Photo by M. Bartosch
Apologies to my readers that no new contributions have appeared on the Schlichter Files for two weeks, and in particular that I did not get around to responding to some of the questions and comments on my blog. I hope to rectify this shortly. I was committed to a few speaking engagements in connection with my book Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown. Also, the brokerage firm CLSA was so kind to arrange a whole string of meetings with their clients in London and in Milan on the topic of the book, and this has taken up most of my time last week.
Last week was supposed to be a major week for Europe. We had the ECB meeting on Thursday and then another EU summit to ‘solve’ the eurozone debt crisis on Thursday and Friday. Of course, nothing has changed, nothing has been solved, and quite frankly, I do not see any reasons whatsoever for changing my analysis of what is going on and how all of this is likely to end – badly, that is. If anything, the events of last week confirm that authorities are adamant to continue travelling further on the road to complete currency destruction – not only in the eurozone but equally in the U.S. and the UK, although the latter two are managing to escape closer scrutiny by markets for the time being. As usual, I felt that most of the commentary in the media was missing the main points.
The problems around the world are essentially the same. After decades of ongoing and generous expansion of the fiat money supply, of artificially low interest rates and cheap credit, banks are hopelessly overextended, asset markets are distorted, and sovereign states are bust. I sometimes get pushback on the last point. Are they really bust? – Yes, most of them are. They have acquired debt loads and spending habits – now very deep-rooted and practically impossible to eradicate – that require constant new borrowing at fairly low interest rates – cheap credit forever. Obviously, that is not going to happen. The end of the forty-year credit boom has arrived. The private sector is no longer playing ball.
What needs to happen? The overextended credit edifice needs to be cut back to a size that is commensurate with the underlying pool of real voluntary savings and with underlying real income streams. Money printing and the constant attempt to manipulate lending rates down have to stop. The market has to finally be allowed to set interest rates that reflect the true cost of available savings, and to liquidate what is not sustainable. Deleveraging, default, and debt deflation are necessary to bring the economic structure back into balance. Is this painful? – You bet. It is also unavoidable. There is no other solution. Yet, the solution is deemed politically unacceptable and it is thus being fought tooth and nail. Not only in the US and the UK, also in Europe.
The entities that are most under stress in this scenario are the banks and the debt-addicted states. You know my forecast: the central banks will be asked to underwrite the states and the banks directly with the help of the printing press on an ever-larger scale, and this will ultimately lead to higher inflation and finally to paper money collapse: the end of our present fiat money system, the latest experiment in the sad history of unlimited and fully elastic state money systems.
While this is broadly a global story, many people question whether it really applies to Europe. Isn’t the ECB more conservative, more Bundesbank-like, and thus less prone to debt monetization than the other central banks? Is there not some real effort being made in Europe to sort out the fiscal problems? – No. Most of it is simply theatre that has no or little implication for the final outcome. Let me explain.
The EasyB.
Like the other major central banks around the world, the ECB played its role in setting the world up for the credit bust by providing the cheap credit for the preceding credit boom. The ECB’s balance sheet – or rather the consolidated statement of the Eurosystem as it is correctly termed – started out at less than €690 billion in 1999. On the eve of the present credit crunch, in the summer of 2007, the balance sheet had reached a size of €1.2 trillion. In fact, over this period the ECB’s balance sheet had grown faster than that of the Fed. Like all other central banks, the ECB has, since the crisis began, become the lender-of-last resort to ever more banks and also to state institutions. At the end of 2011, the ECB’s balance sheet will be more than €2.4 trillion – its largest size ever, and also more than 20% larger than at the start of the year!
And as Mr. Draghi, the ECB’s top central banker, told us on Thursday, the growth of the central bank’s balance sheet will continue. More than four years after the crisis started and more than three years after Lehman collapsed, none of the problems in the European banking community are fixed. This is evidently the case as the European banking sector is still in desperate need of ongoing and, this is important, growing central bank support. In fact, the ECB announced more ‘liquidity’ measures to prop up the banking system this week. It also stated that it would lend money against an even wider range of collateral than previously. These measures are similar to the ones announced a week earlier by the major central banks around the world, which were also designed to lessen funding pressures among the banks. We can only conclude that the state of the banking sector must be extremely precarious.
Can all these banks ultimately be ‘eased’ back into lasting health and operational independence by the central banks? Of course, not. A reduction in banking capacity via a shrinking of balance sheets and potentially via defaults is ultimately unavoidable. Again, the banking sector overdosed on years of cheap credit. The boom will not be extended forever. Rehab is inevitable. So are the present measures of the central banks aimed at slowing this process, at postponing it, at sabotaging it or even completely avoiding it? I fear that the key decision-makers don’t even know the answer themselves. They simply want to buy some time, I guess.
The ECB had by Thursday night also fully reversed its timid and tentative rate hikes from spring and summer and was thus back to record-low policy rates. Developments last week thus confirmed my outlook: None of these central banks have an exit strategy. If you believe that these so-called unconventional and extreme measures are temporary, and that policy will be normalized at some stage, you are mistaken, in my view. The biggest direct beneficiaries of cheap money from the central banks are now the ‘private’ banks and the sovereigns, and as the shrinkage and/or failure of these entities is deemed politically unacceptable, and as the states in particular cannot cut back their expenditures and thus their deficits meaningfully, the central banks will continue to print money.
It is somewhat astonishing that in financial market debate and in large parts of the media coverage of ECB policy, the idea is conveyed that the ECB was being particularly stringent. This is due to the fact that many now demand that the ECB provides not only ‘unlimited’ direct support to the banks but that it should also manipulate directly the prices of certain financial assets, in particular the prices of governments bonds of weaker eurozone states, to an unlimited degree, because many banks hold huge quantities of them and they struggle with the lower and, I would suggest, more appropriate market prices for these securities. ‘Unlimited’ bond buying, however, is something that the ECB struggles with, at least officially, and that hits some raw nerves in Germany. Draghi’s negative assessment of large-scale bond buying in the press conference made all the headlines last week, and this is what helped to give the impression of conservatism and policy tightness.
ECB, photograph by Florian K
The whole affair is complete theatre, of course. The ECB has indeed been engaged in sizable price-fixing operations in the government bond market for quite some time and is still conducting these operations today. Every week, the ECB buys bonds of weaker eurozone states in an attempt to lift their prices above normal market-clearing levels. Such indirect funding of state spending via the printing press is against ECB-rules, as Mr. Draghi confirmed again in his press conference. However, it is being done continuously by the ECB and defended with the ridiculous excuse that these operations are needed to allow a proper transmission of ECB policy. This is a blatant lie, of course, but apparently all this money-printing, market manipulation and rule-breaking still doesn’t go far enough for many in the financial industry who now demand even more money printing and more market manipulation. Please remember that the ECB presently limits its bond buying to €20 billion per week. If it only continues at this pace, which I expect it to do until it will give up its faint resistance and accelerate bond buying, the present procedures will add up to more than another €1trillion by next Christmas, and thus mean that the ECB’s balance sheet has expanded by another 42% in a single year! But, according to financial market economists, that is not enough!
None of this is a solution but all that market participants (and politicians) want is apparently some peace and quiet, a little pause in this unfolding disaster. Of course, it is only a question of time and the ECB will accommodate the wishes for even more aggressive money-printing. Again, I consider most of the debate theater.
Inflation will rise
What will all this money-printing mean for the purchasing power of money? – The answer is clear in my view: it will mean rising inflation, then accelerating inflation when confidence in paper money erodes and when central banks will find it impossible to restore such confidence through tighter policy.
It is truly remarkable that four years into a major credit correction, none of the major economies has registered any deflation. Of course, those who have an irrational fear of deflation and declare it an evil to be avoided at all cost will consider this a success. The truth is, a deflationary correction would be the natural response at the end of an extended inflationary boom based on artificially cheap money. Deflation would be part of a necessary, if in many ways painful adjustment process. This process is aborted via aggressive money printing from the central banks. We can clearly see that nothing has been solved and that the channels through which money debasement occurs have simply changed but that it is still ongoing.
Inflation in the eurozone may not be very high at present but it is above target and it will, in my view, continue to rise. The idea that all this money printing is not only harmless but also positive because it avoids deflation is nonsense. In the case of Britain, we are told every month that the Bank of England needs to keep rates low and its balance sheet expanding to avoid deflation and economic contraction when inflation has continuously been above target and in fact rising. Something similar is now unfolding in Europe. Easy money is supposed to help the banks and the states but enough of it is leaking into the wider economy to continually debase the monetary unit, while failing to initiate another artificial boom in the wider economy. I consider what we are seeing in Britain a good blueprint of what will unfold elsewhere in coming quarters: rising inflation (now above 5 percent in the UK), ongoing central bank balance sheet expansion (whether labelled officially ‘quantitative easing’ or something else), an overall weak economy with rising unemployment, failure to reign in budget deficits.
Fiscal consolidation and fiscal integration
It can only be a sign of desperation that grown and otherwise intelligent people believe that the solution to Europe’s debt problem is fiscal integration or policy coordination. This is at a minimum naïve. Debt levels and budget deficits are not where they are today because of a lack of coordination or integration among the member states. They are where they are because NONE of the states can live within their means.
A. Merkel, Photo by World Economic Forum
Fact is that all members of the club have been shown to be habitual over-spenders and fiscal-rule breakers for years. The risk that in a fiat-money union some members may run excessive deficits and then expect to get bailed out by the other states or via the printing press, thus being rescued by a process that involves taking from the tax-payers in other countries (via fiscal transfers) or by taking from their own savers and savers in other countries (via higher inflation), was understood and clearly seen from the start of EMU. That is why certain rules were implemented: budget deficits shouldn’t exceed 3 percent, overall debt levels not 60 percent, there was a no-bail-out provision, and the ECB was banned from bailing out states with the printing press. ALL of these rules have now been broken. Germany insisted on the Maastricht criteria which restricted overall state debt to 60 percent of GDP. Germany herself is now at 83 percent – and happily signing up to new commitments in bail-out-funds that should not be possible under EU rules to begin with.
All fiscal rules have by now been broken. Bail-outs have been implemented and the ECB is funding member states to the tune of €20 billion per week!
But now, these politicians tell us, now we can finally trust them. Because all these cheaters and fraudsters will now check on one another very thoroughly as part of ‘fiscal integration’ under a new set of self-imposed restrictions and with a new treaty, and this will turn a club of rogues and rascals into a group of prudent and trustworthy guardians of the public purse.
This whole idea only deserves ridicule. It is completely laughable. Of course, it will not work. Sadly, it is also presented to the public with that specifically distasteful ingredient of bureaucratic micro-management. Obviously, the member states only trust one another to obey the rules if all decision-making is minutely coordinated and policy-setting on everything from corporate tax laws to bank regulation carefully centralized under a new European super-state. We will get more state-interference, more centralization, more meddling in markets, more and higher taxes and more capital misallocation. What we will not get is less government spending. All power to the bureaucracy!
The endgame does not change because of any of this. The only question is this: Will this impress the markets and restore some stability for a while? I doubt it.
In the meantime, the debasement of paper money continues.
27 Responses to Last week in Europe – Some thoughts on the ongoing crisis
Leave a Reply
Schlichter Book
OUT NOW! Click for Amazon
Recent Comments
{ Hello Jamie, I don't want to pile on. This is important stuff and there is... } – May 17, 3:57 PM
{ Hi Detlev, I recently bought and read your book. Wanted to start reading it again... } – May 17, 3:42 PM
{ Jamie, I do take that into account. Every week the US government has to borrow... } – May 17, 10:35 AM
{ Hi Detlev, Thanks for your detailed response. Obviously we have a difference of opinion on... } – May 17, 9:01 AM
Hi,
thank you for your book: it’s very instructive. I have two questions.
1. How do you deal with one of the main criticisms against the Austrian school, the fact that it apparently rejects the use of mathematical and statistical models as a tool of scientific discovery?
2. I am just at Chapter 3 so perhaps my question is premature: what is the consequence of the fact that the European Central Bank is not a lender of last resort? Why is Germany against it?
Thank you again for your book!
Dear Detlev,
A couple of days ago Goldman Sachs let it be known that it thinks the balance sheet can be (and needs to be) widened otherwise there will be a horrible deflationary spiral. They say that huge amounts of money can be created out of thin air without damaging the “real” economy because the private banking sector – that is in desperate need of this money – would not not hand it out to the economy just “keep” to fix their balance sheets etc. So no inflation to be feared. Is that complete nonsense to your mind or is there any economic sense in this statement? Thanks
Hello Detlev,
I believe that the final outcome of this mess (inflation / deflation) will be decided by the markets at the other side of the Atlantic as most debts around the world are dollar denominated.
The U.S. Bond Market is the last bastion of the credit bubble. Central Banks, and the Fed in particular, are still allowed by the market to issue new currency because the market perceives that the fresh new debt created by the US government is still creditworthy.
The Fed needs a creditworthy debtor who issues new debt to monetize it and therefore increasing or at least maintaining the money supply, because this is a credit currency system, not a fiat currency system.
If you are interested, I´ve written a post about this:
http://eleconomistaprudente.wordpress.com/2011/12/12/response-to-robert-blumen-on-deflation-money-is-not-credit/
Couldn’t agree more and thank you!!
[...] This article was previously published at Paper Money Collapse. [...]
Another great article Detlev.
Also I enjoyed your slot on the Keiser Report, Funnily enough I emailed Max Keiser a week ago and suggested that maybe he should invite you as a guest, however it looks like that one was already on the cards! Will you be posting a link on your site?
I have some questions.
I’ve been myself thinking a lot about the outcome of this, since I have all my net worth in cash. I did get rid of my apartment a couple of years back because I felt that interest rates were ridiculously low and it couldn’t go on. Sadly I had not enough knowledge of economics to know that through money printing central banks could impose negative interest rates via fake inflation.
The obvious answer to money printing would be gold or silver, but I still have some doubts about the outcome of all this. After a certain point, because of inflation, most people will simply become unable to consume (let alone the fact that they are in debt). Wages cannot be increase because states and companies are broke … so the only outcome is social unrest and all that goes with it. Let’s assume that the governments managed somehow to cope with that, then rising oil prices would block companies as well after a while.
I’m just saying that even if you don’t understand the fundamental problem it becomes quickly obvious that this strategy does not work (Bernanke apparently recently said that he cannot print oil).
I’m just wondering if in the end, it will not be forced upon central bank that they stop printing money, whatever the consequence might be. For example letting banks fail (except for the retail part), and then print for other companies.
Anyway, I was just wondering if you could see deflation as an outcome of all this.
PS: one thing that bothers me about gold is that
-you really don’t need any gold to be on a gold standard
-a gold standard would not be appreciated by asian countries that were creditors and have less gold than the debtors
-the price of gold, as a non-investment object say jewelry, is really high. So by investing in gold you are really betting on high inflation/currency collapse.
A deflationary outcome would require, as you state yourself in your question, that the central banks stop printing money. This is certainly possible. In fact, it is what I would recommend. At some stage, the market must be allowed to set interest rates again – freely and uninhibitedly – these interest rates would then reflect the truly available pool of saving and the true cost of capital. What is not sustainable at these interest rates, the market would liquidate. My point is this: after decades of constant money printing the dislocations in the economy are now so large (excess levels of debt, overextended bank balance sheets, various asset bubbles) and the modern welfare is so dependent on cheap credit, that central bankers will be forced to keep printing money. Inflation and currency collapse are not inevitable but likely.
Hi Detlev,
But you can look at it the other way: Low interest rate are a consequence, not a cause of the credit bubble. Because as more agents load completely their liabilities, they are not able to demand additional credit, no matter they refuse to borrow more, or if they are willing to borrow but no creditor will lend to them.
As the level of indebtness advances at the pace of the global credit bubble, the potential demand for credit reduces as more balance sheets are expanded to its maximum capacity, so the credit supply has to chase the demand by offering lower interest rates.
The bubble would stop when the last creditworthy potential debtors (USA, Japan, Germany…) begin to saturate their liabilities as well. If the market stops to trust those countries as it did with Greece or Iceland, then the monetization of debt by Central Banks becomes a very thorny issue.
The Fed does not have that problem yet or the BCE with Germany, but if the bond markes begins to plunge (because fear of default, not because fear of inflation) it is doubtful that Central Banks will sacrifice themselves and destroy their main business which is to issue currency just to bail out the people (the governments are indebted on behalf of the people, not on behalf of themselves).
Besides, if the market has no room in their liabilities or refuses to borrow, the currency (credit) will not circulate down the economy unless the government spends it, which will again lead the bond market to a Greece like situation. I know that it does not seem like it, but deflation is waiting around almost every corner, it´s going to be very difficult to escape.
In the seventies, with a much lower level of indebtness, inflation was much easier to achieve. And by the way, inflation was much more damaging for the people that unlike today, had a quite low level of debt. But now, with such a huge level of debt I see high inflation as a difficult outcome, considering the banking system is the one that decides about the currency and at the same time impersonates the role of the creditor.
An excellent article and I’m very pleased to see that someone has cut through the BS that the MSM propaganda has published regarding the latest euro summit.
I like the concise explanation of the ECB crisis. The points are very salient. One thing not mentioned is the $704 trillion US derivatives market (http://www.bis.org/statistics/derstats.htm) , unless you count it in the ‘overextended credit edifice.’ $704 tillion is 50 times the US annual GDP of $14 trillion. Worldwide derivatives are probably over 1.2 quadrillion dollars (86 times the US annual GDP). That is also real money that is created out of thin air and in circulation. The control of prices in the derivatives market is of even greater importance than the supply of money but they are closely interlinked as well since everything is valued in trust backed currency (a.k.a. fiat currency). Control of that derivatives market can easily steam roll any country that gets the idea of an interest-free government controlled currency. But the derivatives market needs losers to maintain that control and those are the retirement plans, savings plans, and health plans of the 99%. Every large investment house invests in derivatives to reinforce or hedge positions. But even the derivatives market is fragile and susceptible to currency volatility and people’s trust in it.
I think the global derivatives market is potentially a source of great disruption but in my analysis it is mainly just another avenue for out-of-bounds risk-taking by banks, with such risk-taking being systematically encouraged by the provision of lender-of-last resort central banks, unlimited amounts of fiat bank reserves and unlimited liquidity. So what I am trying to say is this: specifically integrating the derivatives market into my analysis might have complicated the presentation of my work without gaining a lot in explanatory power. That is why I have focused relatively little on the modern derivatives market in my analyses. Please also note that the nominal size of the derivatives market is very misleading. The numbers are gargantuan but it is not unreasonable to assume that a lot of these positions cancel one another out. Additionally, these positions do not constitute money or even money substitutes. To my knowledge you cannot use derivatives to buy goods and services. Most of these positions can best be thought of as off-balance sheet bets. If you and I enter a bet on the future price of a sports car that is worth £120,000 today, then the notional value of our contract may be £120,000 but we will only exchange the difference between the future price of the car and today’s price at the settlement date. Additionally, you may hedge yourself by entering an offsetting bet with somebody else on the same sports car. Now the statistics would show the total volume of outstanding derivatives contracts to be £240,000, that is our original bet plus the new, offsetting bet that you entered. The real problem is this: when one or two major derivatives players get into trouble this will have massive ripple effects throughout the entire financial system. It will most likely threaten many other institutions. You can probably guess what will happen: Everybody will be deemed ‘systemically important’ and too big to fail. The pressure on the central banks will be immense to bail everybody out. Again, all these risk-positions constitute not a claim on the equity capital of these institutions but ultimately a claim on the printing press. That is the major threat to the fiat money system.
I do agree that central bank bailouts will fund any large bank derivative failures like the 2008 crash. I would agree on the minimal effects if all derivatives were exercised. But 90+% of derivatives expire worthless. Because of the time premium, they are not cancelled out by opposing positions like you state. The derivatives that expire worthless come out of someone’s pocket and it is a continual large dollar stream into the pockets of those who sell derivatives. The $1.2 quadrillion is the value of the derivatives in that flow, not their underlying assets. I see the metals market being price fixed largely to avoid confidence in metal backed currency and avoid losses in the derivative market. Class action suits against banks like Goldman Sachs pertaining to price fixing are usually settled with a gag order to avoid raising any suspicion with the general public. I still agree with what the article states. I just think it underestimates the power of banks to price fix and cause chaos in the markets through derivatives, flooding the market with a commodity, restricting a commodity, and just plain setting the price on a commodity. I imagine the central banks have engineered a solution of a metal backed paper currency and when that occurs, the chaos will settle down to “show” people the solution is so great. I would like to see H.R. 1098 Free Competition in Currency Act pass in the US. Abraham Lincoln’s greenback (which was an alternative currency to the Federal Reserve) was a great success, stable, and caused prosperity for several decades. Unfortunately central banks paid politicians to rescind the greenback but it was still trusted and traded for years after. Thank you for the great article and keep up the insightful writing.
Art, I think you should read following article by Robert Murphy: http://www.instituteforenergyresearch.org/2008/06/23/speculators-not-to-blame-for-high-oil-prices/
It highlights especially one major flaw in the argument that speculators control the price of commodities, and that is that the price of the futures contract ultimately has to be matched by the price dictated by supply and demand on the spot market. Derivatives do not withhold or increase commodities on the market so they do not influence the supply/demand balance of a commodity directly.
You are also wrong stating that Lincoln’s greenbacks were a success, they were a total failure. Lincoln started with Demand Notes in 1862 which were irredeemable and very quickly lost value. This resulted in Legal Tender Laws that forced the greenbacks to be accepted. By 1874 specie payment was reintroduced due to the failure of the fiat greenbacks.
The period under Lincoln and the Civil War was a period of fiat money and it is a perfect example of the inflationary effect of fiat currency that ultimately results in disaster. The solution then was a return to gold backing which resulted in deflation, which was a good thing.
I would agree with Detlev that in today’s world there will be no reduction of the money supply allowed by central banks and a voluntary reintroduction of the gold standard is completely unthinkable, and thus we will not see deflation.
That article seems dogmatic without practicality. It is an article on oil prices. How does it explain the price of oil going from $140 a barrel to $35 a barrel in six months starting in July 2008? Did demand go down that much or was the market manipulated to create many times more profit from derivative speculators in the know? Who but the central banks could influence a 75% drop in the price of a commodity integral to all production on the planet and where the demand was growing? It was then conveniently followed with a US government bailout on Oct 3, 2008 which took the attention off the drop in oil prices.
Demand Notes and Greenbacks were two different things. Greenbacks were successful because the US government backed them (i.e. requiring acceptance for payment). The inflation of the civil war was caused by the Federal Reserve System. The Greenback was President Abraham Lincoln’s solution to that inflation. He was held over a barrel by the Federal Reserve System. The Greenback caused the subsequent deflation because there were fewer Greenbacks in circulation than Federal Reserve Notes, they were required to be accepted for payment, and as a matter of basic macro economics, prices deflated prices as the quantity of currency was reduced. It was President Lincoln that said, “The money powers prey upon the nation in times of peace and conspire against it in times of adversity. It is more despotic than a monarchy, more insolent than autocracy, and more selfish than bureaucracy. It denounces as public enemies all who question its methods or throw light upon its crimes. I have two great enemies, the Southern Army in front of me and the bankers in the rear. Of the two, the one at my rear is my greatest foe.”
My typo. Should be ‘prices deflated as the quantity of currency was reduced.’
I don not think the article is even the least bit dogmatic, it is a very logically argued and backed by what actually happens in the real world.
You are also completely wrong on Lincoln and Demand and United States Notes. United States Notes were also known as Greenbacks and until 1861 were backed by gold. Lincoln came into office in March 1861 and specie payment was suspended in December 1861. This led to huge inflation during the civil war, which did not end until specie payment was resumed in 1874, 9 years after Lincoln’s death. This is what triggered the real deflation in the quantity of money.
Lincoln was also not held over “a barrel by the Federal Reserve System”, because the Fed did not exist until 1913! There was no central bank between 1837 and 1913 but rather a relatively “free banking” system.
Bottom line is that prior to Lincoln and the civil war greenbacks were backed by gold, and it was Lincoln that suspended this backing which led to the inflation. Lincoln did nothing(!) to reign in the inflation of the civil war.
Your Lincoln quote has also been revealed to be highly dubious: http://hnn.us/articles/760.html
Germany finished? I see them throwing us into into an deflationary downward spiral and chancing Europe to an concentration camp.
Easy, Gabriel, easy. There is a lot to criticize about the so-called “German position” in this euro-mess. But the basic thrust of trying to reign in deficits and make the debt load more manageable is correct. Those who call this austerity and who suggest that it would be better to go for more growth have to explain how they are going to achieve this? By running higher deficits? Well, more government spending does not lead to lasting prosperity. The idea that society gets richer if the government spends more money (money it doesn’t have) is obviously nonsense. Does anyone really still believe that this will provide some magic ‘spark’, some ‘stimulus’, for self-sustaining growth? Com’on! Besides, most of these governments cannot fund their spending in the private market (by issuing government bonds) any longer. So this money would have to be printed by the ECB. So deficit spending and ECB money-printing as a viable alternative to “German austerity”? Think again. We are in this mess because of all the money-printing and deficit spending of the past as I explained in may of my blogs. The problem with the German plan is that it does rely too much on raising taxes and that there is all that annoying micro-management of the economy in it (over-regulation, for which the Germans have indeed a fondness). I am very much anti-taxes! I am also an advocate of outright default. Rather than impose draconian taxes on the productive part of the population, the government should default on its debt. This would probably cut it off from further borrowing (good!) and teach an important lesson to those who gave their money to these governments in the first place rather than invest it in productive enterprise. It would finally force the state to shrink. Now that would be a proper recipe for growth! Lasting growth that is, not the artificial growth boosts from easy money. Alas, it won’t happen. I said Germany is finished because it is itself already on a rather slippery fiscal slope. Ultimately, the ECB will print much more money. That is still my prediction. And it will end in disaster.
Detlev,
This disaster is the normal end of fiat cycles. Even now in a later stage you
can buy a lot with this stuff. Ask Fed and BOE. But it seems more dangerous to me
breaking that natural rule of cycles and trying to reinforce the illusion of value. I was in Greece and saw who has to pay for this.
Detlev,
I bought your book and couldn’t put it down until I finished it. I am a big follower of the Austrian school and the work of many of their authors and I completely agree with your analysis and research. I agree with your timeframe as well, but I have two questions. Does the ultimate collapse depend on more money printing / bond buying by the Fed and ECB or is it possible to prevent the coming crisis if the course was reversed immediately? Also, do you see this crisis happening in a few short trading days or over the course of the next 5 years or so?
Many thanks, Rob. I don’t think a crisis is entirely avoidable any more. The accumulated imbalances are already too big to unwind without any major damage to the wider economy. The choice is the following: 1) stop printing ever more money, return to ‘hard’ money and allow markets to set interest rates. This will most certainly start a process of liquidation that will surely include a number of big defaults. 2) continue to fight liquidation and price-corrections (labelled by the mainstream consensus ‘deflation’) at all cost. This requires ever more market intervention, in particular the printing of ever more money and the direct support of ever more asset markets and of banks and state borrowers directly by the printing press. This will not avoid liquidation forever but must lead at some point to a currency crisis. Both outcomes are painful but 2) much more so. The collateral damage for the healthy parts of the economy is considerably larger in scenario 2). If your question is whether a crisis can be avoided, I would say no. If your question is whether a total currency collapse can be avoided, I would say yes. I believe it is more likely that monetary authorities will continue to try and fight liquidation and deflation and will continue to print. The crucial question is when does the public lose confidence in the system.
Hi Detlev,
great and informative site you have and I’ve read every single one of your blog posts. Only contention I have is I wish your book had come out earlier on the scene but better late than never as they say, and there is (hopefully) time to get prepared for whatever outcome arises out of inflation/deflation.
I’m also of the opinion that the end-game is inflation unless this crisis is allowed to run its course.
So notwithstanding that eventual end-game how deep into the deflationary environment could we sink before the Fed, BoE, SNB et al go on a final no-holds-barred print to infinity psychotic bender?
Just recently we’ve had big drop in gold (something to do with gold leasing which had had expired, I think) although this does not alter anything as the fundamentals are still in place.
Is there anything else which might play out in the run-up to hyperinflation and how does the current scenario compare to the previous inflationary collapse of the 1930s.
As back then people were not indebted like they are today and what other factors (unique to this time) could potentially throw a spanner in the works of these politicians who will instruct their Central Bankers to take the path of least resistance thereby taking us all down.
Some very good questions. I have no crystal ball. I know this system is suboptimal and it will end. There can be little question about that, in my view. Given the present dislocations, it will also end badly. How badly and how soon? I think reasonable people can disagree on that. I think the endgame will be inflation and currency disaster. But could there be another deflationary correction before the central bankers go for the inflationary overkill? It is possible but unlikely in my view. These guys already have the foot firmly on the gas pedal, and I see no change in their strategy whatsoever. We are four years into what should be a credit correction, yet we have nowhere deflation but inflation everywhere. Central bank balance sheets are expanding at an unprecedented speed, wider monetary aggregates are growing at a solid pace, prices are rising. There is a lot of talk of deflationary risk – and I think this is not justified. Inflation will continue to rise. Once the markets demand a proper premium for monetary debasement it will get interesting. The central bankers are now the lenders of every resort and are boxed in. I do not enjoy sounding negative all the time but as my friend Tim Evans says, the system has properly check-mated itself. It promises to be quite chaotic.
[...] y de línea dura, está crucificando el sur de europa en nombre de un euro fuerte, según señala Detlev Schlichter en su blog, al final de este año el balance del BCE sumará 2,4 billones de euros – un 20% más que a [...]
Detlev,
let me disagree with you at least once: “It promises to be quite chaotic”.
To me, it is quite chaotic already!!!
Latest ECB’s chief Mario Draghi outcry with European politicians is a good sign. The new interest rate cut is supposed to give relief to the banking system. Anyway, Draghi seems to argue he hopes banks (of course within their ‘sovereignty’) will use the new money to purchase more bonds of troubled countries. Interestingly, soon after, the latest Spanish bond auction has seen a peak in demand with spreads falling in one shoot from 5.something to 1.something!
Plus, it seems that EU will contribute with 150 billion euro in new funding to recapitalise the IMF. The goal seems to be the IMF to help solving the euro debt crisis! (???)
Among the contributors it appears Italy will provide its quote of about 23 billion! Wait a minute: isn’t Italy under insolvency threat right now? Isn’t Italy passing right now another austerity bill that is (supposed to) rise about 20-25 billion euro to reduce its budget deficit? I would expect also Greece to be asked for a contribution!
I do not have any knowledge to understand these kind of financial alchemy and probably this EU funding will be done in the usual dodgy way to make it appear as an asset in the balance sheet of the lenders. I simply do not know!
But, it is no wonder the UK’s answer when asked to contribute for its part! To me, translating for political to down-to-earth language, it seems UK replied something like: “what the hell do you think you are doing!!!”
If this is not pure chaos, what else?
[...] to City AM this morning), the deal reached by EU leaders last week doesn’t change a thing. Here’s Detlev Schlichter on the ongoing crisis: The problems around the world are essentially the same. [...]