This book traces fraud from its first definition, the use of two measures (outlawed in Deuteronomy 25:13–19), through recognition that only the universal application of the standards laid out in this book’s appendix (that force the exposure of frauds) can perpetuate financial market stability.

The underlying cause of all financial crises is a collision between fraud and truth. Fraud hides leverage, whether by misrepresentation, theft, or manipulation (including corruption and monopoly). Truth exposes the leverage, and debt is senior to equity. Thus, the necessary consequence of a collision between truth and fraud is a sudden reduction of equity values—a financial crisis caused by exposure of theretofore hidden liabilities.

Ben Bernanke explained the collision of hidden international trade imbalances that caused the 2008 financial crisis, by undeniable logic, to an assembly of the world’s monetary policy leaders in Berlin in September 2007. He revealed a world in which equity value was exposed to $67 trillion of hidden trade imbalances. Liability for that imbalance had been hidden from investors by the application of a second measure of debt (off-balance sheet liabilities) that attorneys, auditors, regulators, legislators, business and political executives, and investors somehow became convinced they could ignore. Now these same leaders talk about capital, rather than fraud, as the cause of the crisis.

In the clarity of hindsight, the investment community was deluded. Whether reported or not, all hidden debt is somebody’s obligation; and for the economy of the world to function, debt must have priority over equity. To prevent crises, therefore, all debt must be exposed. The problem is not insufficient capital, but inadequate disclosure.

For more than six years now, deluders and the deluded have stumbled together into a $67 trillion hole of debt contraction that government had no choice but to fill. America’s greatest economist, Irving Fisher, proved that beyond anyone’s doubt in 1933.

Investors were rescued only because the financial system must survive or the world will return to the Stone Age as humanity is devoured by environmental forces that must, somehow, be contained to avoid human extinction. We’ve known how to cure a debt-contraction deflation or depression since 1933, and Ben Bernanke was the world’s economic conductor to orchestrate its recovery from the Armageddon of 2008.

We now therefore know that the world, acting together, can resolve any financial crisis. What we cannot do, however, is eliminate the consequences of exposed truth. We can provide liquidity to markets and absorb undisclosed obligations that can be funded as exposed debt, and we can forgive debt that will never be collected.

Even debt forgiveness, however, does not end income tax liability. Exposure of hidden debt (created by theft, fraud, or plain stupidity) creates income to the extent it is not repaid. Uncollected debt exposes obligors to taxation. When a business fraud is exposed, repayment and taxation reduce liquidity and earnings. When public corruption is exposed, elected officials go to jail and dictators generally flee or die.

In the case of innocent loss and particular hardship, bankruptcy discharges tax liabilities, but no nation of free peoples can long tolerate any other program of tax forgiveness. To do so rewards cheats while burdening honest taxpayers. It is, therefore, rare that an amnesty program for tax collection in a democracy will forgive taxes that are hidden from collection by even the most innocent errors. In the United States, one measure among its 2008–2010 crisis-resolving tax stimulus programs allowed long-term deferral of debt forgiveness income. It led to abuses and soon ended. But even if abuse can be resolved so that program can be reinstated, it only defers taxation.

Recent events in Ukraine exemplify the ages-old problem of a corrupt regime ending when it comes in conflict with the success of economic freedom (there represented by the euro). The president of Ukraine fled and Russia may protect him because Russian leaders find it difficult to fully embrace freedom. But even Russia has found free markets difficult to oppose. Russia’s leaders have acknowledged that investors fled Russian stock and bond markets in response to their actions in Ukraine.

To date, U.S. markets have shown little, if any, harm (and may have benefited) from Russia’s difficulties. Charts 9.1, 9.2, and 9.3 show remarkably low and stable U.S. credit spreads throughout March, April, and May of 2014, while credit spreads for Russia and its businesses rose dramatically. The problem is the impact of holding Ukraine hostage on the success of the euro.

The 1979–1981 U.S. experience with Iran is instructive for Western Europe. Like Iran’s seizure of the U.S. embassy and employees, Russia has created an immediate and significant threat to peace and prosperity in Europe. Within a month after the U.S. embassy was seized in Tehran, the Carter administration adopted regulations for resolution of Iranian financial assets it had frozen in U.S. institutions. Face-saving prevented Iran’s religious dictators from acquiescing to the demands of those regulations while Mr. Carter was president, but they complied immediately after Mr. Reagan was elected and inaugurated.

In Tower of Basel, Adam Lebor persuasively asserts that allowing the central bank of Nazi Germany to participate in the Bank for International Settlements was critical to Hitler’s capacity to finance aggression and murder (Lebor 2013). If the BIS and the ECB construct appropriate financial restraints on Russia’s actions, there is little doubt that Russia will ultimately comply. Care must be taken to take measured actions so egos do not interfere with wisdom, but no nation as substantial as Russia can prevail without the fund flows needed for trade. Western Europe controls those flows. Since the Fuggers’ bank funded the Habsburg empire, history has been consistent on what happens if Europe acts wisely.

By comparison, the much larger issue of unpaid tax deferral overtook U.S. markets in 2014. News about a major litigation finally posed the following question: if the world had $67 trillion of international imbalances in 2007, how much of the income generated by that accumulation of transferred wealth was secreted away in phony off-balance sheet liabilities shifted to tax-haven entities?

The lawsuit was brought by a bankrupt U.S. firm against its tax advisor. It disclosed that standards for sale of financial assets set forth in the appendix are, by law, the tests used by the U.S. Securities and Exchange Commission and Internal Revenue Service. Thus, tax obligations that the bankrupt firm thought it deferred by transferring accounts to offshore entities were, in hindsight, due when the incomplete sales (secured debt transactions) occurred. That forced restatement of the debtor’s income and the incurrence of unpayable income tax liabilities.

The advisor may not be liable for its client’s bankruptcy (after all, the advisor’s opinion only deferred reality—it did not change U.S. tax or securities laws for which the client was responsible). Doctors regularly make mistakes, but not all mistakes are malpractice.

The problem is that a significant number of firms may have structured their tax plans by ignoring the sale standards presented in the appendix. A $67 trillion trade imbalance may create $10 trillion or more of undisclosed tax liability. And we wonder why U.S. equity markets began to fall when word of that lawsuit was widely disseminated in January 2014?

What can be done to avert a crisis from this new collision of truth and fraud?

Collecting taxes without regard to consequences reintroduces the bad logic of the Treaty of Versailles after World War I that led to the Great Depression and World War II. Eliminating tax obligations unfairly shifts the burden of government from cheaters to honest taxpayers.

The solution is a combination of recognition, deferral, and policies that responsibly provide liquidity to the economies of the world to accommodate the errors that were made, and moving on.

That is the theory of financial stability. As investors have realized the capacity of free markets to resolve this matter, U.S. credit spreads have narrowed and equity markets have recovered.