Infinite Stupidity

“The unlimited resources” of the European Central Bank (ECB) are quickly becoming the new magic mantra in political commentary and financial market analysis, now that the bigger euro-dominos are beginning to wobble, and everybody realizes that nobody has the firepower to bail out Italy or to “recapitalize” (i.e., bail out again) all the banks that lent to the country. So the chorus that demands that the printing press finally be put to good use is getting louder by the day.

Robert Preston, the BBC economics expert, last week claimed that the solution now lies with the ECB, and he spoke confidently of the ECB’s “unlimited resources.” Yesterday, Vince Cable demanded “unlimited powers” for the central bank. He also shamelessly regurgitated the well-worn politician’s excuse for Europe’s problems, namely, that these countries are under “speculative attack.” The advocates of large-scale ECB intervention now include many pundits and commentators, plus, a sizable group of financial market economists and strategists, whom decency obliges me to leave nameless. “It is important to keep the ECB engaged,” as one economist put it, “as only the ECB has unlimited resources.”

Such proclamations immediately invoke Albert Einstein’s famous dictum: “Only two things are infinite, the universe and human stupidity, and I am not sure about the universe.”

Everything Is Going According to Script.

None of what is going on surprises me. It is perfectly in line with what I predicted in my book. However, I am ready to admit that I am a bit baffled by the quick willingness by so many people to embrace what is, ultimately, a sure road to complete economic destruction. In Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown, I explain why systems of elastic money are always suboptimal, unstable and, ultimately, unsustainable. A monetary system like ours must, over time, accumulate dislocations and imbalances that will, finally, become so big that their liquidation through market forces is deemed politically unacceptable. Then, out of desperation, an unwinnable war against economic reality will be fought by means of the printing press. Ever more money will be created ever faster in a futile attempt to outrun the market’s urge to liquidate.

In Chapter 10 of my book, I describe the two final stages of a paper money system as monetization of debt and inflationary meltdown. We are now firmly in the monetization of debt phase. This process will accelerate in coming months and quarters. Not only in the eurozone, but also in the United States and in the U.K. All of these central banks will continue to expand their balance sheets aggressively and use their ability to print money — without limit — to support banks, governments and a wide range of asset classes.

Bernanke (Fed) and Draghi (ECB) pointed out, in their respective press conferences, recently that monetary policy is not a panacea for all economic ills. It doesn’t matter. Policy has no other tools left to postpone the inevitable or to make the status quo appear sustainable again. By the way, it is entirely immaterial what Bernanke or Draghi thinks and says. Their press conferences keep Wall Street and City of London economists busy. But these gentlemen are quickly becoming mere extras in a bigger political game, in which desperation rules, and in which they will simply perform their roles of fiat money producers.

When do we enter the final stage of inflationary meltdown? Difficult to say. It all depends on when the public loses faith in a form of paper money that is being printed in evermore bizarre quantities, only to keep states and banks alive and to project some resemblance of normalcy to the masses.

I do not disagree with the mainstream economists on whether paper money central banks can create, essentially, unlimited amounts of money. Of course, they can. That is precisely why gold and silver as monetary assets were replaced with entirely flexible state money under central bank control in the first place. And I do not disagree that we will soon see more debt monetization by the ECB and other central banks around the world.

What is sheer lunacy, however, is to advocate such a policy as a solution, or part of a solution, to our problems. This is where I draw the line. It is simply beyond me how people who call themselves economic experts, and who must have at least a basic understanding of monetary theory and some knowledge of economic history, can seriously advocate debt monetization as a sensible policy tool.

Dr. Strangelove — Or How I Learned to Love the Printing Press

Our financial market economists now cling to anything that promises to buy them time and some stability, even if logic tells them that what they are advocating is exactly the opposite of what should be done. They are not unlike the gambler who knows he should quit, but out of sheer desperation, is rolling the dice one more time.

Of course, there are always those who are imbued in Keynesian economics and other sorts of interventionist myth to such a degree that they honestly think that there is no problem that cannot be fixed with government stimulus. If the medication hasn’t worked, just keep increasing the dose. Paul Krugman (Nobel laureate) and Christina Romer come to mind. But I don’t quite believe that all economists are in this camp.

Whatever their reasons and motivations, it is quite clear that all these economists are now mouthpieces for the establishment. They are all defenders of the status quo, or of what has passed for the status quo for the past 30 years.

Government bonds should again be considered “risk free” assets, and banks should again be considered “too big to fail” and “too important to fail.” This is so the symbiotic relationship between states and banks that fiat money system fosters, and that has been so mutually beneficial to the political class and the banks, can finally be restored. It is a sad spectacle to see people who call themselves economists — and often, even free-market economists — come up with evermore extreme recommendations of how we can fund Big Government.

To the broader public and the economy as a whole, the collapse of this system would be painful first, but ultimately, hugely advantageous. It would allow a renaissance of real capitalism, rather than the continuation of this system of monetary interventionism that has allowed the state to assume control over such vast resources and the financial sector to enjoy uninterrupted fiat-money-fuelled growth for decades.

What good do these economists expect to come out of ECB debt monetization? Do they really believe that once the ECB has committed itself to buying hundreds of billions worth of Italian government bonds, in order to manipulate the yield on these bonds — against market forces — down to what the political class deems sustainable (let’s say 5%), that then Italian politicians will reform public finances in the country? That they will quickly bring down deficits and the debt load to sustainable levels, at which point, Italy can borrow from the market again, the ECB can safely sell its bonds and reduce its balance sheet and everybody lives happily ever after? Does anybody seriously suggest that this scenario is likely, probable or even possible?

The fact is that none of these governments can be trusted to bring their finances under control, as long as they have access to cheap credit, i.e., to funds at “sustainable” interest rates. Germany forced through the Stability and Growth Pact at the start of EMU (does anybody remember Theo Waigel?) that should have limited debt-to-GDP ratios to 60%, only to violate it herself. Germany’s ratio is now, officially, at 83%. The government is already on the hook for another €211 billion under its EFSF commitments, which are now all but guaranteed to come due, as the bailout fund is supposed to cover first losses on bonds in order to maximize its “firepower,” meaning Germany is already set for more than 90% of debt to GDP. And that is supposed to be Europe’s “stability anchor.”

All rules and guidelines that were designed to guarantee the fiscal and monetary stability of EMU and were implemented at its start have, by now, been broken — without exception. Do you think that this will change once the politicians have obtained the unlimited support of the printing press?

“Quantitative easing” in Japan, the United States and the United Kingdom goes hand in hand with growing debt, not debt reduction. Providing a lender of last resort and easy money and cheap credit to governments does not lead to deleveraging, but to the opposite.

Only default and cutting off a government from additional borrowing will reform the government. That is why I say: Embrace default!

The Future

When the ECB will have implemented its backstop for Italian government bonds, it will end up buying vast amounts of these securities at above-market prices. Draining equal amounts of liquidity from somewhere else in the system, in order to minimize the inflationary impact, will be illusionary. Inflation will creep higher. Concerns about sovereign solvency are, of course, not restricted to Italy. These concerns, plus rising inflation, will put upward pressure on the yields of other bond markets, in particular, Spanish and French bonds. The ECB will have to expand its support program in order to stabilize these bond markets as well. Why should unlimited ECB support be limited to Italy? What is good in the case of Italy must be equally good for Spain and France!

The notion that the ECB could ever change course now and tighten policy, in order to fight rising inflation pressure, will appear increasingly fantastical. Market participants and the wider public that uses the euro will simply not believe it. Inflation expectations will rise rapidly. Money will become a hot potato. When money demand falls, inflation will shoot up quickly, which would require the central bank to establish markedly positive real interest rates in order to restore confidence in paper money. But this would mean allowing several governments that are now reliant on cheap central bank funding to go bankrupt. This will not be allowed to happen, which will undermine confidence in paper money further. We will have reached the inflationary meltdown phase.

All complete paper money systems in history were established to fund the state. Our system is no exception, as becomes increasingly clear. All paper money systems in history failed. Ours will be no exception, either. Our system is the most ambitious. We had a global system of unrestricted fiat money production for 40 years. The endgame is fast approaching.


Detlev Schlichter

The Daily Reckoning