Earth has existed for at least 4 billion years. The first humans appeared in Africa perhaps 4 million years ago. Climate changes affecting glaciers apparently caused a group of anatomically modern humans to walk out of Southeast Africa’s environmentally unique cradle and begin populating the rest of the world about 40,000 years ago. We started this discussion with a definition of fraud that might be 4,000 years old. It’s been about 400 years since dissatisfaction with royal rule began the process leading to England’s current constitutional monarchy. The United States will soon be 240 years old—a very young nation by most historical measures, but still the world’s oldest truly democratic republic.

The United States has only 40 years’ experience (one-sixth of its lifespan) with pursuing a workable legal foundation for stable financial markets. The American model promises to replace the bank monopolies by which emperors, kings, priests, and other despots ruled by controlling money (and thereby all people who need and use it). In that tiny span of 40 years, the United States and world economies have sorted out trade and human population imbalances that are monumental.

Any reasonable look at economic and life expectancy data for the past 200 years shows strides toward health and wealth that are unsurpassed in world history. Much of the success in making the world healthier and wealthier occurred during just the past 40 years. There is also hope that the world may yet succeed at efforts that establish the climactic events of World Wars I and II as the end-all for the decimation of many millennia of wars.

Consider how many people live in some form of comfort today compared to the period at the end of World War II, when much of the world lay in ruins. The progress toward freedom and away from war and starvation began with the shocking difference between the assistance that the victors gave to former enemies after World War II and the retribution sought after every other major war in history. By 1973 those former enemies were selling the world superior products that eventually destroyed leading U.S. manufacturers, the same companies that made the machines that overcame the dictators who led those enemies into World War II.

Some may still debate whether George C. Marshall was right to convince the United States and its allies to forgive prewar debts, forego reparations, and aid former enemies. People that argue against what Marshall (and others) achieved by generosity are either stunningly ignorant or outrageously arrogant. In 1790, Adam Smith intellectually trounced all other bases for morality in favor of those based on benevolence. That is what guided the Marshall Plan and it worked far beyond anyone’s wildest dream. It expanded the pie for us all.

You may argue that the United States has systematically blown 40 years of efforts to achieve financial stability by democratizing the control of money using deregulated free markets. But nobody ever tried to do this before. The efforts to date have failed, in part, because we failed to direct benevolence properly. That is a reason to learn from our mistakes and try again, not to give up or go back.

Greed is never good when it is a disguise for fraud, and surrendering to fraud risks the barbarity of letting bullies harm those who deserve benevolence. These are mistakes that will not set us free.

Done correctly, economics proves that sound debt is good. The world has no outside creditors. All debt, therefore, represents trust that some humans have bestowed upon other humans. As we noted earlier, the image of the depositors in Frank Capra’s film It’s a Wonderful Life is also a metaphor for all human interaction based upon trust.

Combined with equity, debt generates capital goods and capital goods raise productivity. Even the most ardent labor economists agree that maximizing productivity is the main long-term determinant of growth in real wages. Seeking productivity without balance leads to a reduction of the demand needed to sustain growth.

This book shows that secret leverage, hidden by a fog of international imbalances, trapped the world in a $67 trillion hole in the presumed 2006 worldwide balance between the debt and equity that support investment. That was a horrific error that could have led to the destruction of all previously generated wealth. It was an error of disclosure and pervasive corruption, however, not of the propriety of sound disclosed debt.

The lost money did not get shipped to Mars. Some people took it from some other people and hid that capital from productive uses. With hindsight, a lot of what occurred during the subprime boom was illegal, but a lot of the rest of it was innocent, though perhaps irrational, exuberance.

In 2006, the world was being told by accountants and businesses that there was $67 trillion more invested in stocks and other equities than there actually was. The difference consisted of an accumulation of $67 trillion in unaccounted debt—shadow banking that created off-balance sheet liabilities. When the bubble burst, this undisclosed debt became a $67 trillion hit to equity—knocking two-thirds of the value off worldwide equity. Panic naturally ensued when this reality was exposed.

For a while, the people of the world were once more on a debt contraction course to total insolvency. This process was explained by Irving Fisher in 1933. The course changed when markets learned that a few central bankers actually knew what was needed to fix the problem. For a year and more, many U.S. and world leaders refused to accept what Messrs. Bernanke and Kohn said in mid-September of 2007. As a result, we fell into a deep financial hole and the world economy nearly imploded.

More than six years later, by a combination of rising equity and nationalization cum monetization, the world has a central bank bridge over that $67 trillion hole. Before the bridge can be removed safely, the world must repair what went wrong with financial markets. That is what will allow a smooth transfer of monetized funding held in central banks back to the private sector as rising equity and disclosed debt refill the hole.

We need to speed up that process. Before the crash, the total value of capital goods in the world was something like $200 trillion. If predictions about the capital needs of the world are anything close to right, we may need $2–$4 quadrillion of debt and equity savings to support a like amount of investment in capital goods to meet challenges the world may need to overcome in the next 40 years.

The only real hurdle is confidence. Today’s low U.S. bond credit spreads are supported by the continuing wisdom of the Fed’s leadership that goes back to the earliest days of the central bank. Fed Chairman William McChesney Martin (1951–1970) is famous for saying that the role of the Fed is “to take away the punch bowl just when the party gets going.” But the real role of the central bank was demonstrated by Chairman Bernanke and his colleagues on the Federal Open Market Committee. It is to lend wisely in times of crisis to prevent the type of debt deflation America and the world experienced in the 1930s.

Looking at the graphs in this book, compare the nearly $4 trillion debacle of 2011 (when a minority within the U.S. House of Representatives created anarchy and cost the United States its AAA rating at one rating agency) to what appears to be a less than $300 billion hiccup when that same group threatened to intentionally force a default on U.S. obligations in 2013. Fed Chairman Janet Yellen, Ben Bernanke’s replacement, will determine not what must be done, but only how easily it will be accomplished. She is certain to be tested in that regard.

The United States has solved the ancient mysteries of financial stability, but we have not implemented the reforms needed to sustain stability. All that is required is transparency plus freedom over exchange without fraud. Experts have affirmed this solution for two millennia, but the rule of dictators, priests, and monopolists and the role of folly and inertia in human nature have prevented implementation. As a result, we recently faced the worst financial crisis in modern history.

From that, however, we may finally understand how to perpetually (1) reconcile imbalances that have historically caused crises leading to starvation and war, (2) prosper with balanced markets by countering procyclical tendencies before they trigger new crises, and (3) confer on the world the ability to generate the capital needed to preserve human life as we know it in the face of dwindling fossil fuel energy and climate-changing pollution.

The problem is doing it.

Chinese is both an ancient and a modern language. Experts challenge those who say that the Chinese characters on the inside cover, translated as crisis in English, also mean opportunity. They say the characters mean a dangerous, critical moment—in other words, a crisis. In the United States, when fraud is exposed, people who fear prosecution react indignantly in denying fraud, even after the existence of duplicity is made certain by exposure. The issue is a matter of semantics.

Fraud can be intentional or innocent. In a crisis, that difference is immaterial, because rescission of an exchange made before the crisis is, in crises, a full remedy for the harmed party. Rescission is available for both types of fraud. If the defrauder is solvent, therefore, crisis creates an opportunity for the victim to redeem loss without proving intent.

Without a crisis, persons associated with fraud deny knowing the duplicity that was perpetrated because in that case, only intentional fraud is significant. Only a knowing fraud creates a private right to damages beyond rescission.

In rising markets, moreover, rescission (by which the defrauded party must give back the original asset) is an ineffective remedy. A fraud victim rarely wants to recover a less valuable asset. So, crisis is a dangerous critical moment for defrauders and, when the defrauder survives the crisis, an opportunity for the victims of fraud.

Fraud, however, creates crises. That is why governments must demand transparency and regulate fraud in good times. Governments must enforce these requirements vigorously—because restraining fraud supports preservation of free market exchanges that preserve financial stability. In good times, moreover, private parties lack remedies to pursue fraud, thereby generating procyclical behavior that increases the severity of crises in the absence of vigorous regulatory enforcement.

Smart investors who are guided by self-interest but lack benevolence pose the greatest risk of harm because they inevitably support the folly that guides most fraud—a far greater danger to society than evil. Evil can be exposed by logic and fighting evil is understood (and broadly supported) as a necessary role of government. Folly, however, is illogical—and therefore difficult to expose.

Generating support to fight folly is far more difficult than creating support to fight evil. Too few understand the need to fight folly because self-interest is observed as good by its perpetrators. Folly is seen as benefiting the individual’s self-interest. So, how can it be bad?

Perhaps worst of all, for people who learn about folly before others, fraud creates opportunity. Before 1907, J. Pierpont Morgan certainly understood that the prevalent abuse of creating leverage in subsidiaries and reporting the subsidiary’s value on a net basis (before consolidation of subsidiaries was required in the 1930s) was a form of fraud. The practice duplicitously hid the leverage in undercapitalized trust companies that blew up in that crisis more than a century ago.

The practice of hiding leverage in subsidiaries was created by the innocence of folly built on the moral hazard of self-interest by managers who benefited as hidden leverage accelerated a rising tide of equity values by the pyramids they built in good times. When things turned bad, of course, that hidden leverage turned “horrid.”

A very smart man, Morgan surely understood that when the pyramids of leverage fell, that the bigger the fraud, the bigger the crisis, and the bigger the opportunity for those able to create new leverage while others were cut off. In 1907, creditors trampled each other as they sought to retreat from leverage by accepting whatever price they could get. That let Morgan’s friends buy just about anything—because new leverage was available to him that was unavailable elsewhere.

It is equally logical that Morgan, following the experience of 1907, would help the United States create its Federal Reserve System in 1913 to serve as a substitute lender of last resort. Even the House of Morgan could no longer play that role. That way he would not need to press friends for funds when the next crisis occurred. It is hard to count on a “fool me twice” strategy. By the time of the next opportunity, his friends would likely understand how they had helped to fund Morgan’s profitable exploitation of the 1907 crisis.

Unfortunately, it appears that Morgan got greedy and may have helped to cause the next crisis, which became the ultimate U.S. economic folly: the Great Depression. He helped structure a Fed that could not pay interest on free reserves. Moreover, Justice Brandeis certainly understood how Morgan and other lenders could use secret common-law pledges to keep the fruits of their last-resort lending while at the same time decimating unsuspecting depositors and unsecured creditors.

Consequently, as the next crisis hit in 1929, Morgan’s folly backfired. His substitute lender of last resort, the Fed, lacked the ability to pay interest, so it could not buy up the unsecured free reserve funds it needed to take up Morgan’s 1907 role. Moreover, both the Fed and Morgan’s intended beneficiaries—the major money center banks—could not demand secret transfers of collateral that let them decimate unsuspecting unsecured creditors (including depositors) of firms that did not prepare for the crisis.

Morgan created a constrained Fed and the U.S. Supreme Court justifiably and correctly demanded transparency in secured lending that precluded Morgan’s bank and others from enjoying the benefits of Bagehot’s dictum—an ability to extract huge profits from a crisis. That forced the United States to follow a very long path of debt deflation out of the Great Depression and into World War II. Indeed, mistakes made during that recovery period contributed to the recent crisis.

It took the United States more than 60 years of state and federal law reform to force sufficient transparency into the practices of pledging collateral to overcome the deceit of retained dominion practiced by J. P. Morgan that “imputes fraud conclusively.” By so doing, however, the United States now forces fair financial statement transparency standards on accountants and precludes off-balance sheet liability and shadow banking deceptions.

As a result, the end of reforms in the United States will be observed when credit spreads stabilize within the complete-market ranges near the bottom of Charts 9.1, 9.2, and 9.3 that track failure and recovery through the recent crisis. By achieving and sustaining that equilibrium, the world will have the resource of U.S. markets and expertise on which to build a worldwide economy that supports debt reconciliation, wealth accumulation, and the sustained living standards of which humanity is capable.

The conditions that fulfill the theory of financial stability are, therefore, as attainable as they are essential for the future.