Paterson’s banker friends set up a new private bank called the Bank of England and bought up government debt in exchange for the right to issue bank notes, or paper money, and a banking monopoly in England. The deal allowed the Crown to consolidate debts in a single, friendly, domestic institution instead of borrowing abroad, where some foreign government might suddenly demand repayment.

At first, the Bank of England bought British paper at next to nothing because the British government was bankrupt. As it bought more paper, prices rose–eventually reaching par and yielding huge profits for the Bank of England and the bankers who had funded it. By the time the Bank of England issued its paper bank notes (or currency) for mass distribution, the once-worthless government debt behind the currency had climbed above par, and merchants and their clients around the world accepted Bank of England notes at face value.

To maintain values, the Bank of England routinely stepped into the market to buy notes whenever they threatened to fall below par, thus driving prices back up and creating a myth of perpetual government solvency. The Bank of England (and its “member” banks) got richer and richer, buying paper when prices fell and selling after they recovered. Bank of England trading in government paper became a cash generating machine for the government. And because the paper traded so widely foreign governments and the general public grew convinced that British government bonds would forever be convertible into “specie,” or gold and silver coins and bullion, at or near face value.

British bonds became a basis for granting public and private credit. Anyone who owned government bonds could borrow against them. With the myth of government solvency implanted in the minds of men, the crown was able to spend without regards to revenues and wage war at will–indeed, build an empire. Whenever the crown needed more money, it printed more paper, which the Bank of England bought and resold on the market by printing more money. The more money the Bank printed, the richer British traders became–as long as buyers and sellers in the marketplace agreed that the notes they used to pay for goods and services were worth what the numbers on the paper currency said they were worth–that is, their “face value.”

Everyone ignored one problem, though. The notes and the government paper behind it were worthless. Their imagined worth was based only on Bank of England promises to repurchase notes at par and the Bank’s promises were based only on government promises to repay its loans from the Bank of England with tax revenues. But it had not repaid a penny and had no intention of doing so. It spent all its money on war.

When Bank of England reserves dried up in 1711, some international traders formed the South Seas Company to buy the ever-expanding national debt for 6% interest and a monopoly in the booming slave trade to South America. South Seas Company stock soared to ten times its par value. In 1718, King George I became governor of the company, and early in 1720, the company bought up more national debt. By August, its shares had soared from 128 ½ to more than 1,000. British trade was riding the crest of a tidal wave of prosperity that seemed likely to grow indefinitely--until the South Seas Co. chairman and directors, knowing that the government was bankrupt and could never repay its debts to the company, unloaded all their stock. The South Seas “bubble” burst. Company shares collapsed to 124, then to near zero, dragging down values of Bank of England notes and British government bonds–and plunging the British economy into deep depression and the British people into decades of inhuman poverty.

Determined to avoid such a debacle when they took office in 1790, American President George Washington and Secretary of Treasury Alexander Hamilton issued government paper backed, in part, by options to buy government lands in the west–i.e., real property. A century later, in 1914, Congress created the Federal Reserve System and backed government debt–and U.S. currency--with gold.

Lyndon Johnson’s and Richard Nixon’s “guns and butter” policies, however, revived the the notion that a nation could indefinitely spend more than it earned. Both presidents found some obscure economists eager enough for fame to proclaim America able to wage foreign wars and expand public spending at home. Gold prices, however, soared to levels that the U.S. Treasury could no longer afford, but instead of cutting outlays, Congress ended the gold standard. Since then, American paper–government bonds and the currency we carry in our wallets–has hardly been worth its weight in paper, let alone gold.

Although the Clinton Administration temporarily righted the American economic ship and produced budget surpluses for the first time in decades, President Bush and his economic madmen, along with gluttonous pork addicts feeding at the Congressional revenue trough, have increased the national debt by 60% over the last eight years to $9.5 trillion. Gold reserves are less than $300 billion, or 1/30,000 of the debt. The Bush government is not only in debt to the American people who bought its bonds, it is in debt to the world–and not just to such allies as Britain, France and Germany, but to enemies in the Arab world–including Al Qaeda–who are preparing to destroy our economy by steadily raising oil prices. When oil costs reach levels that disrupt mass transit, public services and industrial production, they will call in trillions of dollars of American government IOUs that the Bush government has blithely written over the years. Then, when the president’s ill-conceived tax cuts expire in 2010 and personal taxes rise 25%, the American economic bubble will burst and produce widespread bankruptcies, unemployment and poverty that will be far more painful and affect more Americans than any terrorist bombs.