The Cobden Centre

This article is the sixth in a nine-part series on credit.

The other great class of credit whose extinction is not to be trembled at, but instead warmly welcomed, is the otiose round of ‘pig on pork’ interbank (and inter-‘shadow’ bank) lending and borrowing. This is an activity which serves little useful purpose beyond the basic one of allowing a limited series of transfers from a depository with preternaturally cash rich clients and atypically few cash poor ones, so that it may fruitfully collaborate with a sister institution in the converse situation, to the shared benefit of all. Outside of this, for Bank A to lend to Bank B so that B can buy the paper issued by Bank C which then deposits the funds with Bank A, each hoping to extract a few basis points advantage from the deal in their turn, is a gross exercise of financial incest, needlessly tying up resources and capital, both.

In fact, if we look at the instance of Europe, the truth is that, for all the undoubted pain and dislocation being suffered as we transition from an unsustainable whirl to something (hopefully) more sober and well-proportioned, this has been exactly what has been taking place.

In the three-and-a-quarter years since Fannie, Freddie, Fuld and AIG FP exploded our mass delusion that we had reached the Land of Cockaigne simply by pooling, slicing, and layering in upon itself more and more debt, granted on easier and easier terms to worse and worse borrowers, European banks have actually increased their aggregate lending to households and private non-banks in the Zone by €760 billion and they have extended €350 billion more in credit to EZ governments (not an unmitigated benefit, this, of course). In marked contrast, they have reduced lending to one another by over €310 billion, withdrawing another €500 billion or so from non-Eurozone banks along the way. [There are, naturally, exceptions to this broad generalization, notably in Spain – where business lending is a hefty €100 billion below its April'09 peak. The point, nonetheless, remains a valid one].

None of this is to argue that the stresses are not very elevated, nor to pretend that the inevitable differences in the applied microstructure of such vast sums have not thrown up large numbers of winners and losers – whether deserving or undeserving – but it cannot be overlooked that with 35% of their total Eurozone assets consisting of exposures to one another (and 55% of the extra-EZ loans and non-equity securities on their balance sheets funding banks outside the single-currency area), they still have €11 trillion – some five times their combined capital – to go, if they are to shrink back to a less leveraged footing without doing more harm than is necessary to the world of work it is supposedly their primary purpose to serve.

Back in the day, arch Eurocrat, Jean-Claude Juncker, boasted that he and his fellow King Canutes vouched to ‘fully assure’ that no ‘systemically-important financial institution’ in their fiefdom would be ‘allowed to fail’ – the arrogant aside being that all the Zone’s 6,000-plus credit institutions fell into that category of NTBTF – No-one Too Bad To Fail.

Such an exercise in Hubris inevitably called forth the savage shade of Nemesis and so, three years and more later, we have reached a pass where hardly a single SIFI can assure its peers that it can be saved, nor its sovereign’s rating with it.

Accordingly, many observers point to Europe as making the case that the crisis has finally vindicated Keynes and delivered us, not just to the zero-bound, but to a veritable absolute zero of economics where the ability of money to have any effect has been completely frozen out.

But, far from Europe being the exception that proves the rule, so hopelessly have its drowning banks and foundering governments come to clutch at one another as they sink that much of the ECB’s present intervention – vast as it is – may not be a means of direct inflation, at all, and so cannot be deemed to have ‘failed’.  You see, what is mostly afoot in Europe is that the national components of the system are simply being drawn into inserting themselves – providing a credit wrap if you will – between former correspondent banks in the different member states who have come to harbour unallayable suspicions about each other’s true standing and so will not deal directly with one another as was their wont.

If we imagine that, in the good old days, a Spanish house-buyer might have borrowed from his local bank to stock his house with shiny, new German, kitchen appliances, this would have led to their export manufacturer adding to his monetary holdings at a German bank, with this last being happy to ‘recycle’ this fraction of the Great Teutonic Current Account Surplus by lending it back to the original Iberian agent of inflation.

Nowadays, alas, such insouciant laissez passer has become unthinkable, forcing the Spanish lender to close the gap by repoing or selling some of its securities holdings to the Banca de Espana. The German creditor likewise prefers to place his funds on deposit with the Buba and the transmission is completed between the two via the TARGET system. ECB assets – and the portion involving government bonds – will thereby have risen without any new monetization of debt whatsoever having taken place.

To see some evidence of this putative exchange in action, note that the Bundesbank’s intra-ECSB exposures rose €360 billion in the three years after September’08, the Netherlands’ by €80 billion (the pair having put on another €90 billion between them in the following two months), while German bank claims on other EZ members declined €180 billion and Dutch ones by €35 billion. A further leakage was to be found in whatever part of their €245 billion combined cutback of exposures to EU banks outside the single currency it was which related to the three English clearers who access the system via the DNB.

On the other side of the ledger, the data show also that the ECB’s balance sheet waxed €540 billion fatter, (to which not insubstantial total the NCBs added another €910 billion during the period in question), by way of the acquiring – among other ‘assets’ – €250 billion in Euro area governments and €690 billion in claims on the region’s banks and offsetting this with €1,040 billion in deposits accepted from the MFIs in their turn.

To gain a sense of the scale of these numbers, we may note that, in the year to last November, the Buba’s TARGET balance rose to 20% of German GDP and the change was equivalent to 125% of the whole twelvemonth’s current account surplus. For the DNB, the comparables were 25% of GDP and 100% of the surplus – and lest us not forget that the Bank’s dealings with Lloyds, HSBC, and Standard Chartered may make that a low-ball estimate, given the net drain likely to result from the UK’s own deficits.

Now we come to the nub of the matter. Note that, in the 22 months from August’08 to June’10, Eurozone government net liabilities increased by around €1.150 trillion. Of that total, no less than €573 billion – pretty much a half! – was bought (monetized) by the MFIs (+€443bln) and the ECSB (+€130bln) between them. In that same stretch, EZ M1 expanded at a rip-roaring 12.6% annualized pace, or by €920 billion – so the fiscal deficit alone was responsible for five-eighths of this significant inflationary impulse.

From that point on, it was downhill all the way, however, and while the next year-and-a-half saw the central bank increase its rate of accumulation (+€151bln), MFIs were now trying to dump some of the toxic waste they had been previously seduced into warehousing, cutting their total by €119 bln to leave a picayune, combined addition of €31bln (again giving some credence to our ideas of a shift between monetizers occurring, rather than an outright intensification of their joint efforts).

Guess what was the upshot? If you said money supply slowed to a recession-threatening stall, you qualify for a gold star. In contrast to the incipient Weimarian rush which went before it, M1 inched up by just €62bln, or less than 1% annualized – barely a twelfth of the increment per month which prevailed in the preceding spurt. Reversing from multi-year highs, this spurt just pipped the time-span to the LEH Crash itself to set a Euro-era record nadir for any like period.

Keeping in mind this direct, intuitive linkage, there is therefore no prima facie reason to bemoan the supposed inability of the modern, unanchored central bank to influence the money supply, no matter how firmly the course is set for a general retrenchment of borrowing: it simply needs to make up its mind to ruin the currency and act in a way which is consonant with its aims.

We re-iterate the point we have made over and over again throughout this episode, following the ideas of Leland Yeager: for as long as the national currency has not been totally repudiated by its habitual users, money does not have to be lent into existence, it can be spent into existence by the state. Should that state be temporarily indisposed – which may be the case in the ‘Zone – as our Lords and Masters at the central banks have gleefully discovered, they nonetheless enjoy a near unlimited scope to buy up existing, as well as newly-issued, non-money assets from the non-monetary sectors by writing cheques upon themselves and so, by this means can engineer any increase in demand deposits they wish – i.e., create as much new bank money as they will, even if it means they must nationalize the whole apparatus of finance along the way.

Thus, the issue is a matter of politics, not economics. As central banking insider par excellence, Charles Goodhart, aphoristically put it, long before the current turmoil erupted, ‘deflation is a policy choice’.

As I argued in yesterday’s article, disruptions caused by an artificial excess of credit will squeeze margins and lead inevitably to the demand for yet more credit. Taking this particular tiger by the tail may well defer the day of reckoning, but only at a steep cost. The business first becomes unprofitable, then barely cash generative and, at last, a mere Ponzi scheme reliant on infatuated bankers and intoxicated shareholders for its continued existence, but ever more susceptible to any shock to its credulous sponsors’ confidence as its balance sheet deteriorates in lockstep with its chances of achieving any more than a specious, bubble-supported, stock-jobbing sort of return on invested capital.

Indeed, it is in this pathology that we might seek the explanation for a very curious observation; namely, that certain key measures of business confidence, such as the US NAPM or the German IfO (themselves usually responsive to changes in business revenue), tend to wax and wane in opposition of the ratio of a ‘broad money’ measure – such as M3 or total banking assets – to a narrower, more proper M1-type gauge.

One has to think about this for a moment to see how perplexing it appears on the surface. Here we have the blessed ‘multiplier’ in full operation, with several dollars of credit being added for each unit of new money created and yet industry is becoming more, not less, uncertain of its prospects as they are.

From a mainstream perspective this makes no sense at all, but, to an Austrian the answer may be that the oversupply of credit has served to hyper-extend the chain of production in the manner outlined above. The fundamentally alien, unintegrated nature of much of that incremental activity means its cash flow is at best scanty, at worst negative. We might say that the ‘length’ of the Hayekian triangle or cone we use to envisage the productive structure has become disproportionate to its volume (broadly the total revenue flow rate of the economy), given that the height of end-spending has not only not become reduced to compensate (as saving takes place), but is actually now pushing higher.

Only the cement of credit can shore up this unstable edifice, but with the mortar increasingly lacking the  monetary fixative necessary to maintain its integrity (through generating sufficient means to make interest payments, meet amortization schedules and the like), this, too, will soon give way and – barring the implementation of an ill-advised, official policy of forced petrification – which seeks to immure the living so that the zombies may be spared the tomb – the ensuing crash will usher in the grim austerity of the Bust to succeed the giddy abandon of the Boom.

Up to that last roll of the dice, as Hayek himself phrased it, we will be suffering from the foredoomed tail-chasing of ‘an investment that raises to the demand for (finance) capital’, though some will see this fateful scramble as a sign of a potentially remunerative chance to fulfil the falterers’ importunate demand for funds. Sadly, those who hold that ‘as long as the music is playing, you’ve got to get up and dance’ tend to find this is no Jazz Age Charleston, but rather a deadly tarantella.

In a passage we have frequently quoted for its insight, the great Richard Cantillon expressed it thus, according to the usages of his own time:

In 1720 the capital of public stock and of Bubbles which were snares and enterprises of private companies at London, rose to the value of £800 millions, yet the purchases and sales of such pestilential stocks were carried on without difficulty through the quantity of notes of all kinds which were issued, while the same paper money was accepted in payment of interest. But as soon as the idea of great fortunes induced many individuals to increase their expenses, to buy carriages, foreign linen and silk, cash was needed for all that, I mean for the expenditure of the interest, and this broke up all the systems.

This example shews that the paper and credit of public and private Banks may cause surprising results in everything which does not concern ordinary expenditure for drink and food, clothing, and other family requirements, but that in the regular course of the circulation the help of Banks and credit of this kind is much smaller and less solid than is generally supposed. Silver alone is the true sinews of circulation.

Substitute properly-defined ‘money’ for ‘silver’ and think TMT, sub-prime, and Chinese reflation instead of the South Sea Bubble, and you have it in a nutshell.

Once the mood shifts, of course, there arises a general desire to pay down existing debts and an anxiety not to incur more, a restorative tendency which strikes terror into the heart of all the capering tribe of macromancers – befuddled to a man, as they are, by their economics of collective paradox, their reverse quantum mechanics of counter-intuitive large-scale phenomena.

For, by their will-o-the-wisp lights, if no-one stands ready to reinforce failure by outspending his means, the moment his neighbour rediscovers the compelling logic of good husbandry, this disavowal of a dreary cortège of serial ruination implies that a total and coincident ruin must instead be the sorry result.

It should, however, be clear from what we have argued above that since much credit is not in any way actively monetized, and that money is what ultimately counts, the discharge of that portion of the stock of credit should have few further consequences beyond the benign ones of reducing one man’s exposure to the soundness of another and hence of lessening the financial vulnerability of all – not least that of any bank which happened to intermediate between the two.

After all, where this is the case, in order to pay off his borrowing, the debtor must either have gained command over a valuable asset, contributed to the production of a good, or performed a useful service – i.e., he must have been a net economic contributor. To extinguish the charge held against him, he must make shift to offer one of these directly to his creditor, or else to sell them for money to a third party and offer that in its turn.

His obligor, who earlier was only holding an unfulfilled title to a future economic satisfaction, is thereby given the concrete means with which to enjoy the fruits of his former thrift with no further delay, whether by reinvesting the money (or goods) received in a productive undertaking, or by going out and spending what he has been rendered – or what he has thus been spared from expending elsewhere – on some good, old-fashioned, exhaustively indulgent consumption.

How can this be an ill? Is not to say so the same as to argue that if I borrow my neighbour’s lawn mower, promising to cut his lawn, too, as a quid pro quo when I return it a week hence, I occasion my benefactor real harm by actually doing what I promised to do? In the same vein, if we do consider this an evil, should we insist, henceforth, that no-one ever be permitted to deliver into an expiring futures contract, but that he must roll the position eternally forward, lest he bring the market for grain, or gasoline – nay! the entire global economy – shuddering to a halt by closing out his position?

Moreover, if it is (almost) universally accepted that we all routinely partake of the bounties of voluntary exchange in order to increase our mutual satisfaction beyond what we can each hope singly to achieve, how can we argue that the mere introduction of a time delay between the two halves which make up every bargain transmogrifies the second component – but never the first, you will note! – into an act of social violence? And if it is so insisted, where are we to set the threshold for this noxious change? Five minutes after the first goods have been dispatched? Five days? Five weeks? Five months? Five years?

In my previous article I explored the disco-ordinating effects of unnatural interest rates.

Let us go back for a moment to construct a simplified version of what it is we are considering, with the aim of better understanding it. Imagine that along the chain from seed merchant to farmer to grain shipper to miller to baker to wholesaler to retailer to Mrs. Jones, out for her weekly quota of patisseries, there is a flow of goods from the higher orders (i.e., starting with the seed merchant) through the lower and on into our dear housewife’s shopping basket. While this segmented process of production takes place, time inevitably passes as an incomestible, raw material is sequentially transformed into a sought-after item of everyday consumption, with value being incrementally added as the metamorphosis takes place.

Initially, the farmer may lack the means to pay the seed merchant so he asks for, and is granted credit by his vendor – the one generates an entry for accounts receivable, the other for accounts payable. The farmer, in turn, may well have to do the same to the man who comes to collect his grain and so on, all the way down to Mrs. Jones. Such credit as is granted here is implicitly connected to a decision on the part of the grantor to forego an equal amount of current, monetary recompense and hence, makes him automatically him into a saver. Not in the least inflationary, such a process of credit creation is thus an entirely benign aid to industry and commerce, if practised in due proportion and with a due degree of diligence.

As our Mrs. Jones dips into her purse and passes over her pennies to the shop assistant, MONEY now moves back up the chain, and extinguishes each debit in turn as the promissory notes, invoices, or bills of exchange come due and are settled. By way of avoiding an infinite regression, Mrs Jones, we may assume, gets her cash from her husband’s job at one of the firms involved, this first amount coming into being when someone saved the money to provide the firm with its start-up capital, long before it was generating any saleable output. Thus, Mr. Jones’ effort provides the household with its daily bread, both literally and metaphorically.

Note here that each member of this division of labour has to await his own fulfilment until after the final good has been sold. Once that has been accomplished, each receives a portion of this selling price to the extent of his individual contribution to the value attached to it by Mrs. Jones’ decisive exercise of consumer sovereignty. To the degree that each member has correctly judged the management of his affairs, he will receive a little more than he himself laid out – whether this expense took the form of his purchase of the products of those passing firstly the raw, then the several intermediate, and lastly the finished good onto him, or as part of his direct outlay to his workers, his landlord, and his equipment suppliers.

At that point, his entrepreneurial judgement having been fully validated in the marketplace, he and his capital backers can enjoy a well-merited reward. However, it is also the case that, having received both his revenue and the endorsement of the firm’s owners, each of our captains of industry has the choice to buy more or less of what he bought before, to put the difference to use in improving the firm’s chance of future success, or to quit the business entirely, extracting what capital he can along the way.

This means that, far from being something which we can take for granted once Mrs. Jones steps into the store – as the traditional, GDP-type, consumption-fixated methodology insists is the case – each of these steps is highly discretionary. Each is, moreover, subject to the continuing practice of good management and unwavering entrepreneurship to maintain an unbroken flow of goods. At any point, changes in any of the constellation of conditions influencing each business, or in the motivation of and possibilities of compensation for those running it and investing in it, may mean it becomes either not possible or simply not desirable, to carry on with it– an eventuality which cannot fail to have significant ramifications for both customers downstream and suppliers upstream of that business.

Contrary to the way they are normally dismissed from contemplation, as being mere residuals to be cancelled out in our measurement of that misleading aggregate of aggregates we call ‘the economy’, all these activities are therefore vital to its functioning and should be treated as such in our every analysis. Importantly, we should bear in mind that while net new investment may be what is needed to improve the capital stock and to increase the division of labour (to add ‘roundaboutness’, to use Boehm-Bawerk’s formulation), it is gross investment – i.e., spending with a view to creating, not exhausting, value – which is a sine qua non for the very maintenance of the extant stock of productive machinery. Anything which serves to reduce it, therefore, ultimately reduces both our wealth and our income, even if its temporary substitution with more end-good spending gives a speciously attractive boost to the guiding calculus of the GDP numbers.

Thus, by way of analogy, we can imagine the step-by-step generation of income as being akin to a relay in which each participant passes a baton on to the next to signify both the movement and further working of the goods-in-process all the way to their final destination in our good lady’s larder (perhaps the baton should be marked with notches as a tally to record the credit being extended at each stage as well).

Once the finishing line has been crossed – and the palm awarded by the end-consumers gathered there – the prize money is passed back up among the runners, with each subtracting his cut as the pot reaches him in his turn. For each, that cut constitutes his own spendable portion, i.e., that part beyond the requirements of his continued involvement in the scheme of production. Further ensuring economic harmony – what we Austrians call ‘plan co-ordination’ – their sum matches exactly with that quantity of final consumption goods which all those involved have helped put on the shelves and which have been duly selected for purchase from among all the competing merchandise ranged alongside them there.

Now consider what happens when each man can take his evidence of a credit claim on another and have it turned into money at the bank. Effectively, each of our relay runners now has his own baton and he can choose to leave his lane, dash across the infield to the finishing line, and there compete with all his fellows in pre-empting the goods piled up there by others, well before they have collectively ensured that their own have been successfully delivered to be offered in exchange.

More money chasing fewer goods – i.e., the potential for giving rise to what Charles Holt Carroll called ‘price without value’ – is the first result. The second is the temptation to start ‘check kiting’; i.e., to divert the monetized claims in their entirety – not just the expected net income component of them – to non-essential or even ultra vires purposes, such as, stock market or real estate speculation, hoping then to meet each bill as it comes due, not out of cash flow, but by cashing in speculative gains or raising further inflationary finance. The third is the disconnection of effective demand from profitable supply with the risk that, in one’s own hunger to spend earlier than one has earned the means, one ends up earning less than one had thought to, as prices and quantities become adversely affected by the consequences of one’s own impatience.

In Holt Carroll’s own words of 1855:-

The immense variations in the quantity of this delusive currency that we call money, the greater part of which is but a mere “promise to pay” money that has no existence, produce corresponding variations in the money value of property and debts, so that no reliable estimate can be made of property for any considerable period of time. There can be no reasonable reliance that the quantity of money which measures an obligation for six months will be anywhere at its maturity to discharge the debt; and this baffling uncertainty renders the trade of the country but little better than licensed gambling.

While the examples from my previous article may well complete our bestiary of what does and does not constitute inflationary credit formation, what we have not dealt with here is the more insidious evil which wraps itself around the apple tree of our earthly paradise, even when post hoc savings do serve for a while to lend a spurious justification to the speculative, advance extension of credit by a bank.

We refer here to the broad prescription of that Austrian theory of the business cycle to which we adhere. This has it that when such loans are made to business in the absence of a genuine desire on the part of others to save, this inversion of the holistic order is not a boon to be welcomed, but a bane of which to be wary.  This is because the act of severing the link between the decision to save – and hence to free up real resources for other uses – and the appetite to borrow means that such loans can be granted in a manner and on a scale likely to be at odds with social time preference and so at a market rate of interest below the natural rate of future discount. In so doing, a great and dangerous discoordination of the productive structure is encouraged, rife with the unrecognised perils of incompatible planning, contradictory time horizons, and the falsely signalled degree of abundance of sufficient key resources at the price anticipated to see each project through to a timely and lucrative conclusion.

The difficulty here is that what post hoc saving there is tends, at first, to mute the impact as the purchasing power which corresponds to this new credit flows into the hands of what are technically termed the ‘end factors of production’ – principally the wage earners and the salaried classes.  This lull is, however, an insidious one. Indeed, such restraint is better understood using its technical designation of ‘forced saving’ since the phrase better expresses the limited enthusiasm with which it is carried out by people who receive a larger pay cheque but who are not fully convinced that the good times will continue to roll. To begin with, they will not be ready to spend all the extra proceeds, not when nothing on their usual shopping list seems to offer exceptional value and when nothing new has arrived from the expanding, higher-order industries so as to whet their jaded appetites.

Given their reluctance to participate in the necessary forbearance, it does not, however, take much to undam this reservoir of grudgingly-made ‘savings’. Some of that pool’s owners may become more optimistic about the duration of their improved circumstances; some may just be naturally less provident. Either way, their joint succumbence to temptation may edge prices up just enough to trigger a defensive response in their less avid fellows who either begin to notice that the real value of their nest-egg is shrinking or who are forced to dip into it by the higher call being made upon on their income.

However it happens, soon end-consumption will be picking up among those who never really had any deep desire to forgo every trip to the mall until the high-speed rail network, the aluminium smelter, and the new power grid could be built out and could begin facilitating the delivery of just the required amount of extra consumables, thus partaking of a sustainable, self-renewing stream of income as the reward for their contribution.

The usual sorry denouement, then, is that the extra cash (and encashable) balances eventually come to burn a hole in the pockets of wage earners and profit sharers who have benefited from the trickling-down of the initial credit boost given to their employers’ or their customers’ order books. As they start buying more things, it quickly becomes obvious that no-one has thought to increase the provision of these, so fixated have so many would-be entrepreneurs become on coat-tailing on whatever happens to be the main medium for the Boom – a field of activity whose fatal attraction is often that it represents a ‘New Era’ phenomenon, to boot.

More demand being expressed for a temporarily inelastic supply of end-consumer goods means higher prices and, hence, a more elevated reading for the key statistical measure which tracks these – either that or a yawning trade deficit opens up. This can bring with it its own dangers, not least for the hapless foreign suppliers who may also be intoxicated by the miasma of false prosperity and thus induced to commit too much capital of their own to satisfying what cannot be a durable demand. Worse, should their own monetary authority seek to dull the tendency of the home currency to appreciate on this score, the inflationary plague bacillus will have crossed the border with the buyers’ remittances to blight another land in addition to their own.

In modern times it is the first of these, as in olden times it was often the second, which brings forth the threat of policy restriction. More generally, the newly-lit, secondary boom will not complement the primary one, but rather conflict with it, to the point where it may complete vitiate the latter’s evolution. After all, this is taking place in an area which the earlier availability of plentiful, cheap credit was signalling would remain quiescent while the new industries remoulded the overall revenue stream of the economy comfortably to include them. To their utter discomfit, the unexpected vibrancy up at the sharp end of the productive chain cannot fail to divert resources of all kinds – including labour, which they must therefore battle to retain – to seek a greater income by servicing the upswing – a phase Hayek dubbed the ‘Ricardo Effect’.

As a consequence, those involved in such lines of new businesses – remote as they are from satisfying the immediate needs of our reinvigorated shoppers – will face higher costs and lengthened supply schedules because of the same scrambled to meet the reawakened desire for things they are, by definition not geared up to producing. Worse, the reassertion of consumer preferences must shrink the niche in the market they thought they had identified for their own product when credit was easy, inputs seemed abundant, and lucrative outlets readily assured.

For those in thrall to the simplistic ‘circular flow’ concept of the economy, not only does too little of what the parvenus lay out come back to them, but what they themselves need to disburse to stay in business starts is driven inexorably higher by the greater activity they have instigated in spaces they cannot access.

Ultimately, the only way such artificial grafts on can seek to stave off their impending rejection is to raise yet more credit and to try to leapfrog ahead of the mounting cost-revenue occlusion in which they are being strangled.

I concluded yesterday’s article with a note of caution:

we should strictly talk here of such a swollen, but partly immobilized supply of money being potentially inflationary, rather than ineluctably so the instant it is augmented in this fashion.

This point is worthy of extra emphasis in our present circumstances when all too many pundits are pulling up simplistic chart overlays which purport to show that we need have no fear that central bank hyperactivity engenders any risk to our material well-being since generalized consumer price rises (in the West, at least) have been relatively hidebound compared to the vast efflux of ‘liquidity’ provision experienced since the collapse.

One answer to this charge is simply to pose the counter-factual: how much more elevated are prices today above the market-clearing levels they would have – and probably should have – reached absent such an effusion? While empirically irresolvable, this is no mere quibble for if – as was proven by its implosion – Bubble levels of activity included much that was horribly misdirected and, hence, Bubble Era prices were, in many cases, higher than they sustainably should have been, the policy-makers’ success in not only restoring such average levels but exceeding them can only have introduced a greater degree of falsity into the economic matrix which we must take to be our guide in all the exchanges we make.

Indeed, such distortions must be even more severe than they first appear since we must recognise that while it is easy to parrot the news that the general price level is higher or lower than once it was, the single number by which we are accustomed to measure that state hides a world of complex interrelations. In practice, this means that the monetary inflation has not only outweighed the credit contraction in aggregate, but that it has exerted its pressure not so much in propping up values among the main casualties of the credit contraction, but in boosting others – possibly much further in relative terms than they otherwise deserve.

A further refutation works with reference to the mindlessly mechanical usage of many macromancers who spend their days seeking nothing so much as a time series to be set against another, regardless of their provenance or compatibility so as to offer up a sage-sounding divination from the accidental pattern of their overlay.

Just because we can measure an economic quantity (or, more correctly, statistically estimate it according to the available means and subject to certain preconceived prejudices about what exactly it is we are to reckon and why), this does not make it anything other than a crude yardstick of the seething foam of individual decision making whose shape, expanse, rigidity, durability and evolution is the reality we are trying to capture.

Nor does the physics-envy scientism of much economic calculus stand too close a scrutiny. Yes, ceteris paribus, more money chasing the same number of goods should imply higher prices, but the truth is there is very little paribus to much of that ceteris – not least in the intensity with which that ‘chase’ will be conducted, or in the distinction made by the ‘chasers’ (themselves a highly variable population) between different classes of available goods.

As a concrete example of this, consider the fact that the collapse of the credit available in certain (highly-variegated) areas of the economy has meant that less transactional substitution is taking place, with money therefore being made to do more and more of the work, in these dark days of trepidation, for which credit used to suffice when skies were an unblemished azure. Add in a greater penchant for holding financial wealth in the form of money – the addition of whose wonderful optionality in a world of radical uncertainty is something of a no-brainer given the vanishing opportunity costs which have arisen thanks to concerted official action to suppress less risky bond yields – and we have another dampener in place, as mentioned above.

To give this some small degree of context, note that the total of currency and demand accounts held by the non-monetary sector in the US has risen no less than 60% since the pre-crisis year of 2007, with the household component rising 150%, and the non-financial corporate one, 300%. Obviously, not all of this increment represents a precautionary store of wealth – an instant snapshot of a game of pass-the-parcel must show someone in possession of the package, no matter how keen they are to be rid of it – but, doubtless, some good proportion does constitute a ‘hoard’, especially that part held by businesses. This component has risen from 1% of total financial assets (and effectively 0% in QI’09) to a sixteen-year high of just over 4%.

Put another way, in the 18-months to end-September, a sum equivalent to two-fifths of cumulative after-tax profits has been squirreled away by American CEOs desperate for a little clarity of vision instead of being laid out to buy more plant and equipment, to conduct more R&D, or to hire extra workers.

Note, too, that this factor is one which is ironically reinforced by the very same subdued rate of overall price rises to which the naysayers seek to draw attention. That this will prove to be something of a double-edged sword as and when either conditions – or simply perceptions thereof – change, is something to which far too little attention is devoted by those who like to assume what is past (or, in this case, present) must unfailingly be prologue.

Whatever the private sector may or not decide among its members, historically, the most violent and destructive agent of inflation has been Leviathan himself for , in the typical practice, we find ourselves most readily in a situation of blithely turning debt into money when the borrower is the state. Readily able to persuade themselves that the purchase is ostensibly a social service, if all too often a disguised and thoroughly venal buying of votes, the acolytes of the Beast are typically the least considered and most unrepentant of debtors. Indeed, if they ever do entertain any doubts as to their conduct, they have an entire body of Unholy Writ to insist that their studied indifference to the bourgeois values of good housekeeping is, in fact, a blessing to all.

Even this evil is not always a self-fuelling one. If, for example, the bond which is issued to bridge the gap between tax and spend is held by individuals or collectives unable themselves to create the money with which to buy it, we may deplore the redirection of scarce resources into the least efficient and most conflicted of hands, but we cannot call it ’inflationary’: to buy the bond is to deny oneself the ability to purchase other things and to allow these to be conferred upon the welfare case, the defence contractor, or the traffic warden in one’s place.

If, however, the bond is bought by a bank—whether central or commercial—or is pledged as collateral for a loan from one of these, and the resulting dole, once having been disbursed, finds its way back as a demand deposit onto the books of either that same bank or one of its many sisters, the treasury’s deficit has now been monetized in exactly the same way as was the credit granted in the course of the private arrangement we discussed above. No deferral of a claim upon other goods need result from the bond issue, so, in effect, two units of money are chasing what previously only one could – clearly, an inflationary situation, once more.

Likewise, though the pretence is maintained that the government does not simply ‘print’ the currency which comes into our hands, the modern practice by which the central bank issues the relevant notes against the purchase of government bonds makes the distinction a highly academic one. The subterfuge becomes all the more flimsy in the usual case wherein the monetary authority subsequently returns the bulk of the seigniorage gains to the fisc – an act which reduces the ‘cost’ to the exchequer of issuing such happily perpetual liabilities to near zero, even in times when term interest rates have not been almost completely ‘euthanatized’.

As if there were not enough confusion over what policy the authorities should pursue and when in order to extract themselves from a mess largely of their own making (you know our answer: NONE! and NOW!), the analysts of such policy possibilities are greatly hampered in their attempts at exegesis because they are continually tripping up over their hopelessly entangled bootlaces—the one marked ’MONEY’ and the other marked ’CREDIT.’

Moreover, since few of them are careful enough to distinguish between the asset and the liability side of bank balance sheets, further conceptual errors are rife even before anyone tries to bolt his faulty monetary apparatus onto the alarmingly creaky machinery of mainstream macro.

So, let’s start at square one, in the attempt to introduce a little clarity to the situation.

Firstly, MONEY is the medium of exchange—a present good, readily exchangeable into all others at full par value, on demand, and in final settlement of all the transactions in which it participates. In the modern world, this means notes and coins in circulation and demand deposits held at monetary financial institutions by all other non-MFIs, whether firms, individuals, or government departments.

CREDIT, in contrast, is the evidence of a future money claim, of the deferral of final settlement—a very different animal. Although sometimes exchangeable in practice (with or without a haircut) in place of MONEY, it is neither so universally nor so continuously employed. Rather, its circumstantial acceptance is effectively a kind of barter transaction, albeit the kind most regularly performed in financial markets under normal circumstances

As individuals, we are of course fully entitled to give or take credit instead of demanding or offering money, as it suits our mutual convenience. This is especially likely to occur where we are habituated to repeating the process on some quasi-regular basis with a customer or supplier, or where the total invoice is too large for it to be practicable to meet this charge in full and at the point-of-sale.

Note, however, that when non-monetary actors extend credit, they are effectively exchanging enjoyment of a present good for the promise of a future one and, hence, they are principally engaged in altering intertemporal relations—typically via a discount factor. In general, this cannot be inflationary since the lender, by foregoing a cash payment, must surrender his claim on some other present good (effectively, he must simultaneously become a saver) unless he can persuade someone else to take over the claim in his place.

Even if he does succeed in doing this, the resulting swap is simply that—a substitution of one temporary abstainer for another. As such, this can certainly alter the disposition of relative prices— since the seller of the claim has now acquired the means to buy the good at the top of his unique list of preferences, while its third-party buyer has chosen to postpone the realisation of something high up on his somewhat different menu of choices—but this cannot move all (or even many) prices up together.

In contrast, once a bank enters the picture, matters are greatly altered since banks possess the privilege of being able to issue claims on themselves which unquestionably function as money, in the form of demand or other chequable deposits, in this, an era when the issuance of banknotes is typically denied to them and instead is monopolized by the state.

Armed with this capability, the bank can open a loan account for a would-be buyer, allow him to transfer the balance to his vendor, and then sit back and wait until the vendor (or some combination of persons from the chain of subsequent net sellers who are sequentially connected to the first recipient) decides to place the newly-created claim back at the originating bank (or, at minimum, with one of its counterparty banks which latter will then make an interbank loan to the originator of the credit, so as to complete the circle at one remove).

To the extent that these new deposits take the form of demand deposits, the initial CREDIT—which is an asset on the bank’s book—has generated a corresponding MONEY entry on the other, liability side of the ledger.

This is where the inflation creeps in for it implies that the act of granting the loan did not oblige anyone to give up their call on the stock of present goods as recompense for that quantum which was transferred to the debtor, since the seller now holds, not an IOU to be settled many days hence, but a freshly-spawned unit of MONEY, that present good by means of which one can have instant access to all others.

In insisting upon the point that credit granted outside such an intermediation is not inflationary in any overall sense, we do not deny that it can often serve as the basis for a loan-collateral spiral if enough people become sucked into such a Tulipmania of buying and selling a certain class of goods (or claims thereto) on tick – though it must also be accepted that such outbreaks of mass insanity almost invariably accompany periods when money itself is anything but tight and interest rates depressed.

Nor, is all banking involvement of necessity inflationary, for the newly incurred, ex post liabilities which spring up to balance its ex ante lending could take non-monetary form—as time or savings deposits, or as holdings of bank bonds or other term securities issued by the lender – according to the whim of each bank’s customer. (The holding of securities issued by a non-bank is beside the point here, since it begs the question of what their seller – on either the primary or secondary market – will himself do with the funds he has received by dint of their sale).

Moreover, even where they do materialize as demand liabilities—i.e., as money—their owner may voluntarily treat them as part of his portfolio of financial claims and choose NOT to disburse them for long periods of time. ‘Sterilization’ can thus be a passive course followed by the individual, as well as an active policy pursued by the authorities and so we should strictly talk here of such a swollen, but partly immobilized supply of money being potentially inflationary, rather than ineluctably so the instant it is augmented in this fashion.

Since last we wrote, some three weeks ago, there has been little diminution in the frantic torrent of policy proposals, policy adjustments, and policy adoptions with which every economic Actor must brace himself to contend each day before he goes out to earn himself a living.

It has been a constant refrain of ours that such infernal, Stalinist tinkering is one half of the reason that the recovery has been so muted and so uneven in its spread—the other causative factor being the refusal to write off losses and price what this recognition will inevitably leave as a reduced stockpile of capital in an appropriate fashion, once more.

One could almost yearn for the harmless tomfoolery of Roosevelt trying to reinflate the US by arbitrarily setting the price of gold while taking his morning breakfast egg in bed!

The prize for the most dramatic intervention (if hardly that for the most unforeseeable one) is probably due to the move to reactivate 2008’s central bank swap lines, as a means to pull back from the excruciatingly 2008-like levels of basis swaps which had opened up between euro and dollar money market rates.

The danger therein may be truly incalculable for, as the deplorable case of MF Global is beginning to reveal, the dark underside of the zero-interest phase of these past few years and of the generally buoyant asset markets which have accompanied them is that unquantifiable amounts of leverage lurk in the twilit corridors of ‘rehypothecation’—the indefensible process by which one piece of collateral may be pledged many times over to stand as a parody of security for a loan—not least among the 1,400 or so, $1 trillion-plus ETFs (US only) whose issuers avail themselves of such fiduciary ’flexibility’.

No-one would really like to see the network integrity of this Hieronymus Bosch underworld tested by a market-induced seizure: ’For in that Sleep of Death what Dreams may come?’

Ironically, what the swap programme will also serve to do is to add an extra-Zone parallel to arrangements thrown up by the existing intra-Zone logjam, by incorporating yet another layer of central bank involvement in what should be a wholly private matter between consenting-adult, commercial entities.

What is involved in the current impasse is that the surplus countries and their structurally better-funded banks will now only continue to play the systemically critical ‘childish game of marbles’ of Jacques Rueff’s characterisation—i.e., to keep rolling over the mountain of vendor finance obligations being piled up by the cash-poor banks of the deficit nations—if they have a central bank ’credit wrapper’ within which to do so.

Thus, within the Eurozone, for example, since spreads between Bunds and Bonos and BTPs began to widen in the spring of 2010, German banks have so far redirected their focus towards their mother hen on Frankfurt’s Taunusanlage, that they have eliminated 90% of their earlier €200 billion in gross liabilities towards it, moving instead to becoming net creditors to the tune of a nearly equal-and-opposite amount.

Simultaneously with this switch—and offsetting it nigh on euro for euro—it has fallen to the Bundesbank to treat the threatening thrombosis this has created in the Eurozone’s financial circulation by increasing its TARGET-2 net lending to other system central banks from an already elevated €220 billion to a towering €480 billion at the end of October.

Just pause to think what is at work here. In the 2 1/2 years from the end of 2008, Germany ran a current account surplus of around €335 billion, two-thirds of which (~€220 billion) originated in the trade surplus the country ran with its EZone partners.

In this period, German households put €385 billion into building their nest egg of net financial assets, with non-financial German corporates likewise adding €125 billion to theirs. With the state swallowing up €190 billion as a result of its lurch back into hefty deficit financing, a closely comparable €320 billion was therefore left to be disposed of abroad, sending the funds back whence they came—in aggregate at least, if not necessarily in every devilish detail.

Ordinarily, this would mean that those among the ‘Zone’s net importers would borrow the necessary balance from their banks, while those receiving cash either directly or indirectly as a result of German export success would lend it to theirs and these, in turn, would extend credit to their cross-border counterparts, so allowing them to fund their burgeoning domestic loan books.

Come the crisis, however and that has increasingly not been the case. Banks in the importers have had to call ever more heavily upon a local central bank which has then covered its exposure by drawing down on its TARGET–2 account. Surplus CBs, principally the Bundesbank, have then taken monies from the reluctant recyclers in the Heimat and stepped in to discharge the required closing of the circuit in their place.

Thus, the last 19 months’ of growing European discomfort has seen TARGET-2 lending by Germany not only cover the whole of the estimated trade flow of €135 billion, but has put a comparable sum to work in absorbing part of the outstanding stock of the unredeemed bills run-up in earlier years.

Meanwhile, many of the region’s banks had become so desperate to borrow USD that 3-month basis swaps had blown out to a crippling 160bps differential (in world where you have to go more than six years out on the German and up to eight years out on the American govvy curve to fund a comparable outright yield), despite the fact that, between them, they account for a goodly part of the $730 billion or so cashpile parked passively by foreign banks with the Fed.

As such then, the move to offer (primarily) ECB-FRB swaps once more as means to bridge this particular chasm, was effectively the reinstitution of a TARGET-2.i between the two—though it should not go unnoticed that the BoE joined in the arrangement while simultaneously introducing a new collateralised lending facility—purely as a precaution, you understand—under the less-than discriminating terms of which, as one correspondent of ours wryly put it, even luncheon vouchers would be henceforth acceptable.

With a much-reduced, but still imposing £260 billion gap between Sterling M4 (domestic bank liabilities) and M4 lending to close (offshore!) we can perhaps see why the Old Lady was also attempting to meet trouble half way.

Thus far then, the move has been a palliative—a means of applying an official sticking plaster to a suppurating wound of mistrust, of shrunken capital value, unreserved losses, and sharply-reduced franchise value. To prevent this from itself becoming more of a complicating factor in the patient’s condition is, perhaps, laudable enough: but a fix for the underlying pathology it is not.

Nor is it hard to see why the ECB should fly so resolutely in the face of good sense by insisting that no bank should be required to bear any responsibility for the loans it has extended to any Euro-sovereign (or to any of the banks it has bullied them into guaranteeing, in turn). Self-preservation is a powerful solvent of good conscience.

Alas! Given their own terrors of being consumed in the firestorm of cross default which they fear would be the result of such an otherwise restorative seisactheia, we cannot look to the less intellectually-compromised members of the Bundesbank to break ranks with their Bernanke-wannabe colleagues in this crucial matter as the suspicion must remain that their angst on this account makes them all too vulnerable to the scaremongering tactics of those monetary hammer-holders who see every problem as a nail to be pounded in with the application of ever more ‘liquidity’.

But the ECB did not hog all the limelight in the past week, of course, since the new swap deal came in almost the same news cycle as the surprise cut in the Chinese required reserve ration (RRR)—an action which is still open to a much wider range of interpretations than one might think.

On the one hand there is the straightforward bullishness being espoused by the usual crowd of ’Only Way is Up’ Pollyannas who see this as merely the first step in a grand repeat of the insensate orgy of Keynesian folly the Party unleashed in 2009, thereby lucratively bearing up the prices of financial assets and commodity prices and rebalancing the world, go hang!

Well, perhaps they will be that foolhardy. Unlike some we do not pretend to understand the intricacies of the dimly-glimpsed yet constant power struggle which goes on within the various branches of the CCP, nor are we entirely certain to which one of the myriad, contradictory ’advisors’ to this, that, or the other agency or ministry who never cease to perturb the airwaves it is actually worth paying attention for insight about the likely outcome of such strivings.

What we do know is that the PBOC is not the Fed and that the regime does not play by the same rules as do ours. We know that it seeks at all times to enhance its prestige and to maintain its grip on power by persuading the ordinary Chinese that they cannot do without its supposedly benign, Confucian oversight. More we cannot say.

Along those lines, the tightening cycle of the past year was not exactly inexplicable given that the most obvious threats to the Party’s standing was the widespread discomfort occasioned by the rising cost of living and by the growing outrage at the excesses of the plutocracy with which the  Apparat has become so visibly infested.

It was also patent that the means at the PBoC’s disposal with which to address this did not include a rational pricing of monetary capital—not least the introduction of meaningfully positive real interest rates—since this requires both a free(ish) market in money and the termination of the vast, covert subsidy to state-sponsored industrial gigantism which the standard, flagrantly-suppressed funding costs leach out of the average Chinese’s hard-won savings.

Thus, the prospect was for pretty much what we in fact did see: a needlessly protracted game of regulatory whack-a-mole while both real and merely political entrepreneurs engaged in increasingly ingenious ways to avoid the constraints being imposed upon them from above.

The problem with all this policy gradualism was exactly the same one that we ourselves have experienced twice in the past decade—both in the Tech Bubble and the Housing Boom which was intended to be its remedy. Given no fear of sudden shocks and given continued access to funds—albeit via more shadowy, less-legally certain and, hence, more expensive channels—speculation was further encouraged, as it always is in circumstances when the prospective rates of return in the speculative vehicle long outruns the tangible cost of participation in the mania.

Typically, too, more and more economic activity has been sucked into this bubble, to the extent that companies of all shapes and sizes and individuals of widely varying means and sophistication have diverted more and more of their energies, capital, and financial possibilities to playing the bubble, to the point that it would hardly be a shock to discover that a good part of the ostensibly impressive ‘profits’ routinely being booked by the makers of steel and steam irons, of telecoms and teapots, of chemicals and cuddly toys have their origins in purely notional gains on non-core—and possibly ultra vires—property holdings.

Thus, not only do we have the concern that those capitally-intensive, high-order goods expansions unleashed by a lavish application of easy money do not ever end well once the spigots begin to close; or that ‘shadow’ finance can easily morph from being a useful lubricant, to becoming a ramshackle framework of ominously creaking hinges; or that the eager accommodation of over-exuberant, multiply-leveraged purchases of that notoriously illiquid, shelter-providing, durable good which is housing is a guaranteed bank-killer, but we also harbour the awful suspicion that all of these three potential crash-makers may now have become fatally intertwined.

Now, it may be that the RRR hike was purely technical. The PBoC may simply have been practising its avowed ’fine-tuning’ and so, when confronted with preliminary data suggesting that bank lending fell precipitously in November as the scaled-in inclusion of formerly off-balance sheet liabilities in the reserve count took hold, it wisely adjusted the trim on the controls a touch.

This, in turn may have been related to the fact that the reversal in sentiment on the likely trajectory of the Yuan (as signalled by the 12-month NDF rate moving back above the spot quotation) called—as it seems to have done in the past—for a lesser immobilization of funds on the grounds of sterilizing forex inflows. Indeed, this would have been greatly reinforced by news that the tide of those flows had, in fact, turned outward in the last few months and were thus exerting their own degree of automatic restriction.

Finally, the Bank may have been playing good global citizen (or else narrow mercantilist free-rider, according to taste) by responding to the FX swap liquidity announcement from abroad. Who can say?

What we do know, however, is that the authorities have since been at pains not to let the market run away with the idea that the Land of Milk and Honey is just around the corner and that they have not yet finished wringing the excesses out of the property market.  So successful have they been in this, in fact, that the Chinese stock market has continued to meet with selling—an otherwise strange behaviour on the part of those who are purported to think that the clarion has just been sounded for a resumption of 2009’s Bacchanal.

What we also know is that the attempt at mollification is so far being effected mainly through fiscal means—look at the announcement that the official poverty threshold will be raised to such a degree that four times as many people as before (100 million, as opposed to 27 million) will henceforth be eligible for a range of government subsidies and stipends. Further measures include a cap on coal prices and a hike in non-residential electricity tariffs, aimed at assisting badly-squeezed power companies

Economically-conflicted all this toing-and-froing may be: politically, however, the issue is less clear cut since the rigmarole does at least mean the Party can give itself an unlimited role as the arbiter of difficulties and the resolver of problems, regardless of the fact that these are largely those of its own making.

By contrast, to flood the country with money now—with price rises still painful in the memory (and probably in the pocket)—would be to risk not only reigniting popular wrath the minute that those prices reaccelerate in their upward flight, but to throw a large, juicy bone to that salivating Pavlov’s dog of market misbehaviour which answers to the name of ‘Moral Hazard’.

But, but… there is also a hint that the All-Knowing Central Planners may have shocked themselves at what they have wrought, for all their pretensions at close control. Land sales have slumped; lending is evaporating; ‘profits’ have melted like the first snows of spring; unrest is beginning to grumble at the street corners and at the factory gate; SME bodies are comparing this episode unfavourably with the travails of 2008.

As a result, the Party is now trying to demonise internet ’rumour-mongers’ by comparing them to cocaine dealers and the new head of the main TV station has  reminded journalists their first duty was to serve as ‘mouthpieces for the State’. Even more ominously, Politburo law-and-order member Zhou Yongkang told provincial officials last week it was time for ‘innovative approaches to social management’—a euphemism, we are told, for anything from stepped-up policing to boosting unemployment insurance.

“Especially when facing the negative effects of the market economy, we still have not formed a complete mechanism for social management,” Xinhua quoted him. “How to do so is the great and urgent task before us.”

In the circumstances, it is an obvious folly to assert that one knows which way the chips will fall. To quote Heraclitus: all is flux

One thing should, however, give even the most red rag-focused China bulls pause for thought. This is, namely, the question of why they think the Chinese understand the exact state of their complex, sprawling economy of 1.3 billion people patrolled by 80 million Yes-men when, clearly no-one in authority in the US, the UK, or Europe—not Bernanke, not Paulson, not King, not Trichet, no-one—had a clue what was happening to theirs in not entirely dissimilar circumstances, four years ago?

Why, too, do they think that a rapid monetary easing will necessarily reinflate the bubble swiftly and painlessly (or trigger a new one to take its place seamlessly) in China, when it does not quite seem to have worked its fairy dust, inflationist magic outside the Middle Kingdom in the ready manner prescribed by the Beelzebub of Bloomsbury?

Another week of creeping Euro-consolidation was the backdrop to a further round of severe market stress which briefly saw Spain trade at 500 over, and France at 200 over Bunds.

As the clamour accordingly mounted for the printing presses to be fired up—and with rumours swirling that the latest fudge would have the Bank lend money to the IMF so it could keep the credit junkies safe from cold turkey while preserving the fiction of the ECB’s virginity—Draghi’s boys righteously set themselves foursquare against monetizing any more than—oh, the odd €20 billion in government bonds a week— a figure which is around 60% more than the Fed’s average QE-II add and which laudable stringency would only make room for the small matter of €1,100 billion a year, or more than 10% of Eurozone GDP, in injections!

Thank heavens, they’re not going the Weimar route, then!

Showing just how deep the antipathy to this runs, CSU General Secretary Alexander Dobrindt waxed positively incandescent about Draghi’s actions, telling Die Welt that the Bank risked a ‘toxic shock’ from all the ‘putrescent paper’ he was buying. Dobrindt went so far as to wonder if the man from an over-indebted ‘Dolce Vita land’ would become the ‘most expensive’ President ‘of all time’ and stated bluntly that the Germans would never have agreed to the formation of such a central bank if it had been imagined that ‘Italian principles’ would one day inform its actions!

Meanwhile, pressing on against the opposition of even such allies as Dobrindt and Roesler, Chancellor Merkel seemed determined to exact a major surrender of fiscal sovereignty from all the Zone’s debtor nations, current and future, by setting up a German-led Star Chamber to oversee their finances—as the leak of the Irish budget by an unknown member of the Bundestag (yes, you read that correctly) showed up in exquisitely embarrassing fashion.

Love him or hate him, you have to admit that Sinn Fein’s Gerry Adams had a point when he said that there was little point conducting a 900-year struggle against British hegemony if his countrymen were going to hand the reins straight over to a group of outsiders residing in Brussels or Berlin instead.

All this Teutonic uprightness also excited the public exasperation of Luxembourg’s Junckers who rashly pointed out that even Germany’s fiscal glass house might not withstand too purposeful a shower of stones, but it has also generated a good deal of green-eyed rage in an EU Executive which supposedly wants the nation to ‘pay something back’ for its highly inegalitarian enjoyment of record low interest rates.

There are, of course those whose frustrated inflationism will stop at nothing to whip up popular support for their delusions. We have already been told that ‘austerity’ – i.e., the act of foreswearing the further practice of a disastrous profligacy – is self-defeating, as if living within our means and pricing our services to the level at which the market will buy them is to do nothing but deliver ourselves to the very gates of perdition.

It is so common an approach as almost to be a literary trope that, whenever the talking heads wish to scare us into doing something which we instinctively feel is wrong, they invoke some half-digested – or deliberately slanted – parallel with the 1930s. None of these are so emotive as the supposed disaster which was Heinrich Brüning’s ill-starred Chancellorship of Weimar Germany, a term of office during which he provided the doomed deflationist counterpoint to the mythically successful, unalloyed inflationism of Roosevelt’s New Deal, a failure of vision which was given the blame for the rise to power of Adolf Hitler’s NSDAP.

Yet, if we take a newly objective look at Brüning, with a view to drawing lessons for today, we need to do more than mindlessly intone the verdict, unfailingly delivered with squint-eyed, Keynesian hindsight, that Deflation=Totalitarian horror.

True, the exercise in counterfactuals itself will prove only what all such chains of What-ifs are capable of doing; viz., that history is a tale of inextricable contingency far more than it is one of dull inevitability – whether Whig or Marxian. Nonetheless, the fact remains that if the example of Brüning teaches us anything outside of the narrower economic argument it is that there is nothing so effective in undermining faith in representative institutions as the imposition of unpopular policies by decree under the pretext of ‘national emergency’; nor is it helpful to the cause of their acceptance if such measures are at least partly attributable to pressures being exerted by foreign governments.

‘Technocrats’ and Goldman alumni, this means you!

Indeed, it was Brüning’s recourse to the system of Notverordnungen (Emergency Acts) permitted under Article 48 of the Weimar constitution which set the awful precedent for the Nazi’s later consolidation of their grip on power, however expedient such measures seemed at a time when political consensus could not be achieved – and, to some extent, was actively precluded by President Hindenburg’s visceral distaste for any suggestion that the Social Democrats be included in such discussions.

Outside of this – and playing a role both complicated and complicating – was the issue of the ‘fulfilment’ or otherwise of the reparations imposed under the terms of the Versailles Treaty and the opportunity these offered to the mischievous for decrying any policy of domestic restraint, however advisable that may have been at any given juncture.

Here it should be noted that there are those who see the hyperinflation of the early 1920s itself – an almost inexplicable episode of mass insanity, absent such a hypothesis – as a consequence of a deliberate programme aimed at only paying the victors their tribute in a vastly depreciated mark. Less equivocally, it was the ‘success’ of the Dawes scheme of easier repayments of these exactions under the outside creditors’ supervision of German budgetary policy which encouraged a flood of mostly short-term funds into the country. With a weary, contemporary familiarity, this influx served to ignite a pre-Depression boom which was rife with private malinvestment, public sector excess, and too great a degree of ‘maturity transformation’ on the part of the giant, TBTF banks (the so-called ‘D-banks’, in particular) which had become both over-reliant on such ‘hot’, wholesale deposits and desperately stretched as regards their own capital ratios.

Once again, then, we can see the problems of the 1930s arising not so much in the misplaced application of  that inflationist straw man, ‘classical orthodoxy’, but in the vulnerabilities built up during the preceding period of specious prosperity and over-easy money. Thus it was that the world economic structure became ever more distorted in the preceding, ‘Roaring’ decade, thanks to the meddling of a clique of interventionist central bankers – the Fed’s Strong and the BOE’s Norman to the fore. Their abiding aim was to avoid any and all short-run economic sluggishness via a deliberate exploitation of the extra elasticity inherent in the prevailing gold exchange standard in comparison with the tighter constraints of the gold standard proper, and hence, by the concerted suppression of interest rates (each a determined violation of the rules of sound, ‘classical’ finance, you will note).

Amid such a milieu of misplaced optimism and over-extended obligation, a strong case can be made that the critical dislocation which triggered the subsequent worldwide collapse was not so much the fabled Crash of ’29, but the sudden freezing of new credits to a booming German market whose leaders were showing a marked reluctance to accede to the terms of the proposed replacement for the expiring Dawes Plan, as set out under the chairmanship of the eponymous Owen Young. Much as we rediscovered in the aftermath of Lehman’s failure, such a disruption can occasion just as much immediate pain in the current account surplus-lender economies as it can in those of the deficit-borrowers with whom they are fatally intertwined. The repercussions for 1930s USA were of a kind..

Be that as it may, when German business was first forced to face up to the withdrawal of a good deal of the artificial demand which had sustained it though Pharaoh’s seven years of fat, the decision was taken to restore price competitiveness by what is today termed ‘internal devaluation’ – i.e., by a general lowering of prices, wages, and government expenditures, rather than through monetary expansion and currency debauchery. Understandable enough in light of what the country had been through just seven short years earlier.

Though later decried in the most intemperate of terms, in fact the policy initially met with a not inconsiderable degree of success: imports declined in value more than exports and there was even a resumption of international lending as confidence was briefly rekindled by this evidence of a restored competitiveness at home and by a rebound in business activity abroad.

As we all know, this proved to be a false dawn – a cruel disappointment which was not so much the fault of Brüning’s faulty economics as the helplessness of one, lone country trying to counter the effects of a whole series of botched decisions and acts of deliberate malice being practised by its neighbours.

The 1930 passage into law of the infamous Smoot-Hawley tariff made the task of everyone, everywhere,  involved in cross-border trade (and in Germany that was perhaps a third of the work force) more difficult – not least those American farmers who were deprived of their overseas custom by those who could not now earn the means by selling goods to them and their countrymen. As the grapes of wrath were trampled out in the fields of heavily-mortgaged agriculturalists, their deepening plight brought down their own bankers by the score.

Next, the proposed German-Austrian Customs Union (or free trade agreement) – which was intended to give both struggling, post-war rump nations a larger market in which to deal – was not only vetoed by the French, but actually saw Paris orchestrate a run on their banks by way of a reprisal which first folded up the long-sickly Austrian Creditanstalt in May of 1931, then the mighty German Danat bank in July.

Despite President Hoover’s forlorn attempts to broker a solution under the aegis of the moratorium he called on war debt payments that June and despite, too, some half-hearted international central bank collaboration intended to tide the nation over its difficulties, this represented another, near-mortal blow for the hopes of any German revival.

As the dominoes toppled, each upon the next, the largest of them all – the British one – started to teeter. Having carried on a sizeable ‘carry-trade’ of borrowing short term French francs to be loaned at a longer-term premium into Germany, British banks were acutely sensitive to conditions there. Worse still, the thinly-capitalized acceptance houses – brokers of short-term trade credits-cum-monoline insurers – were left reeling when all private credits were also locked in, in the wake of the banking collapse.

At this critical juncture, Britain’s exposure was made more explicit by the publication of the parliamentary Macmillan Committee report into the ability of its financial system to foster industrial growth – a report whose findings were heavily influenced by the Beelzebub of Bloomsbury himself and which therefore contained calls for a ‘managed currency’ and for a further diminution of the role of gold. Not surprisingly, a drain began at once which was not, however, addressed by the time-honoured method of tightening domestic policy, a reluctance which only increased doubts as to the Bank of England’s resolve to defend the status quo.

With similarly ill-omened timing, another parliamentary report – this one issued as the result of the investigation of the May committee – almost simultaneously called the nation’s fiscal position into question and proposed a drastic cut in expenditures and government salaries as a remedy. When news of the last of these provoked a short-lived mutiny among the most affected junior ratings of that part of the British fleet then anchored at Invergordon, it seemed as though Britannia’s unquestioned suzerainty over the waves had been cast down; that the existing order was about to be overthrown; and that the world would soon be delivered wholesale to the clutches of Bolshevism.

Amid the tumult this unleashed, the fateful decision was made to take sterling off gold and so one of the twin pillars of the global financial system was allowed to crumble – the one upon whose considerable girth that system had largely been erected over the preceding century and a half of benign liberalism. The shockwaves were truly seismic, even tectonic, not least because of the  craven pusillanimity of the British defence. As the news reverberated around the globe, a foredoomed struggle for liquidity set in – not least on the part of those other central banks naïve enough to have taken Perfidious Albion’s assurances of good faith at face value and who had either lost reserves, or indeed, suffered a complete capital loss, as a consequence.

In the chaos which ensued, an already etiolated world trade shrunk further and prices once again plunged as competitive devaluations followed one upon the other, to the accompaniment of rising tariff barriers, unbridled monetary manipulation, the imposition of foreign exchange controls and a widespread descent into autarky.

Is it any wonder that the Brüning programme was swept away in this deluge? That unemployment climbed, the state finances worsened anew, and that the soap-box appeal of extremists, both to the left and to the right, mounted among a citizenry too long denied a say in its material destiny?

Having fallen out with that reactionary old dinosaur, Hindenburg, over the proposal to allow jobless Germans to take holdings in the estates of the most hopelessly-bankrupt of the already subsidy-engorged Prussian Junckers, Brüning was summarily dismissed in May 1932, while awaiting a formal resolution of the reparations issue at the Lausanne Conference and ahead of what seemed the long-awaited trough in business activity.

As the man himself claimed, he was ‘a hundred meters from his goal’ when he was ousted. He may even have been correct: the US stock market was about to engage in a 70% rise as industrial production there rose 15% in the course of a few months. Other countries saw a similar bounce and, had it not been for the fraught nature of the autumn electoral contest between the ‘Great Engineer’ (read: the dirigiste busybody) Hoover and the ‘Great Dissimulator’ (the ineffable and utterly amoral self-aggrandizer) Roosevelt which managed to excite one last wave of currency turmoil and American banking failure, that might very well have been that.

So, should Brüning have cut and run? Perhaps. But then again, perhaps not. Did Brüning pave the way for the Nazis? Perhaps. But perhaps it was the legacy of the industrial slaughter on the Western Front and the radicalization of politics which this entrained among a blighted generation. Perhaps, it was the shockingly vindictive nature of the settlement at Versailles. Perhaps it was the bonfire of Weberian values – and capital means – which was the hyperinflation. Perhaps it was the intrusive nature of government interference in every nature of the economy which existed long before Schacht and Goering were squabbling over its commanding heights.

One thing is for sure, for today’s Europe to follow the dire, plutocratic precedents of the Federal Reserve while eradicating what remains of its loose confederalism is more likely to lead to the successors of the Freikorps and the RoterFrontkämpferbund battling it out on the streets of its cities than is the fearless pursuit of individual solutions to individual problems accompanied by a restoration of budgetary discipline to each of the member states. The alternative, as one of the financial experts of the FDP parliamentary group, Frank Schaeffler told Handlesblatt with a clear Hayekian echo, is a “Road to Serfdom,” charging that Barroso – after all, an ex-Maoist – “wants to create the European super-state, without asking the citizens.”

Meanwhile, our once highly-interconnected markets remain shattered into dysfunctional shards of notional (not always actionable) pricing.

Euribor-OIS spreads have widened out to more than 90bps, the highest outside the Lehman spike itself. EUR-USD basis swaps have lurched southward into a similarly deep –90bps in sympathy. Bid-offer spreads are wide and forward forex doesn’t necessarily arbitrage. The concept of general collateral has been sundered into two, mutually exclusive halves, with Bunds—which everyone wants—trading special and the rest—which they decidedly do not—widening out by the day. It is also reported that access to funding has become so restricted that banks are pledging their loan books to eager US counterparts as security for the repo of paper eligible to be discounted at the ECB in turn.

Amid all this strife, one of the mysteries has been just why the euro itself has not cratered. Whence arose the interruption to  the slide from its prior 15% appreciation—a move which was testimony to the destructive power of a Fed whose masters routinely presume to lecture others on the morality of suppressing their currencies? This rise was, in fact, accompanied by a €470 billion borrowing unwind, in the form of a vast flood of money paid back by foreign banks  to their creditor US offices, yet even this could not o’etrump the Fed..

This otherwise paradoxical forex move can only be explained if we assume that the borrowings must have been funding US dollar assets, rather than being devoted to a classic carry-trade, per se—a supposition we can further extend by noting the simultaneous explosion of cash assets on the books of the US subs. This replacement entry grew by a similar $500 billion during that period and may thus have reflected the sale into the US of dollar-denominated securities formerly held abroad and either delivered directly to the Fed, or as substitutes to those who had relinquished their own Treasuries to its NY desk and who now wished to disembarrass themselves of some of that newly-created, QE-II cash.

As some in the market still insist—at the disingenuous prompting of Chairman Bernanke himself—this was not an inflationary act, but merely an ‘asset swap’, to which contention we must reply again, ‘Yes! But a swap of non-money for money—i.e., a deliberate act of inflation!’

After all, was the Fed’s avowed intention not to trigger some of its fabled ‘wealth effects’ by boosting asset prices; did it not ramble on about reducing real yields by pushing up both current and expected consumer prices; did it not even fantasise about the supposedly stimulative effects of dearer crude oil?

Be that as it may, as bank stocks have plunged and sovereign spreads ballooned; as European macro data has rolled over and that in the US has received a fillip which may turn out to be no more than a post-Fukushima renewal of car production, why has the Euro’s decline been thus far so limited?

Once clue might lie in the fact that, since August 2010, European money supply has crept, grudgingly upward by a miserly 1.5%, while that in the US has roared away by a massive 16%. Let no-one tell you that Blackhawk Ben has been slacking in his attempts to refloat the economy on a green tide of money illusion while his ECB colleagues have been models of temperance in comparison

In fact, taking a look at the size of the divergences from the long-term, 2.8%-compound, real rate of growth to which US money supply has generally cleaved since the end of the Great Inflation, this particular incarnation of the all-knowing Oz in the Marriner S Eccles building has presided over both a slump to the greatest negative value of that divergence and a rapid reflation to its second highest level in the record.

Is it any wonder that asset market behaviour has been wild; that forex parities have fluctuated sharply; that interest rates and credit spreads, both, have been highly erratic as a result? Is it any wonder that business executives, owner-managers of smaller enterprises, and ordinary folk, too, have been left bemused and befuddled, too fearful of whatever new policy ’fix’ the morning papers might announce to get on with the business of building a genuine, new prosperity amid the Potemkin wastelands of the old, false one? Hardly!

.

The release of  China’s latest batch of inconsistent and methodologically opaque official statistics were—cue Captain Louis Renault for effect—just about perfect for the job of demonstrating the exquisite degree of control which the country’s enlightened despots are able to exert over the actions of the 1.3 billion people under their sway.

The annual change in CPI ostensibly dropped to a reassuring (if still above-target) 5.5%; industrial production growth edged down to 13.2%; urban fixed investment was still at the 25% p.a. pace which has characterized the past 15 months or so: what was not to like?

The ‘Soft Landing’ was seemingly assured.

Except—forgive our scepticism—but the whole idea of a ‘soft landing’ from a credit-fuelled boom is a risible one.

Once an economy becomes sufficiently distorted by an effusion of newly-created money and too-easily extended credit; once the resulting process of malinvestment becomes not just engrained but actively self-aggravating and its increasingly cashless continuation assumes the role of driver of ’growth’ and wellspring of notional earnings, there remain only two alternatives: to keep adding more and more fuel to it to the point it achieves a hyperinflationary escape velocity or bunker down in some reinforced concrete bolt hole, deep under ground and await the multi-megaton impact of its collapse.

This is not hard to recognise in practice, whether you dress it up by calling it a ‘Minsky moment’, or cite Charles Kindleberger’s catalogue of errors past, or do the decent thing and look at what the Austrians have been saying for nigh on a hundred years, based on a formalization of their close study of the events which took place in the preceding century (something which forms the subject of a slender little volume book called ’Santayana’s Curse’ – ahem!).

The point is that it is of no import how different the details of the regulatory arbitrage, the sources of extra leverage, the nature of the search for yield, or the callousness of the enhanced disintermediation which take place in the credit system might be. Nor does it matter overmuch how disparate the vehicles which come to express the manias these episodes unleash.  Whatever the superficial distinctions, we invariably end with an increasing sterility of what passes for ’investment’, coupled with an increasingly hard to fill demand for what have now become domestically underproduced consumer goods to satisfy the whetted appetites of those who may be paper millionaires, but who are also flesh-and-blood paupers.

Not only are returns on capital appalling in their paucity by this stage, but such ‘profits’ as are booked are either unjustifiable capitalizations of dubious future contingencies or a Gordian tangle of interdependent, below-the-line expenditures. As Prof. George Riesman long ago pointed out, in aggregate, the winners—i.e., those who make more than the natural interest rate—so far outstrip the losers—those who fall short of it—because a bloated schedule of investment is only partially being charged to earnings in each accounting period. Adding to the cheap gilding of false prosperity, all that newly inflated finance is allowing money illusion and Cantillon (first-user) effects to flatter apparent net income, both inordinately and across the board.

Judge for yourself whether this diagnosis applies to China when one of its own dignitaries, Wu Jinglian, member of the State Council’s Development and Research Center, can tell an international audience that:-

Chinese enterprises have entered a bottleneck stage where they face tremendous difficulties in making any further progress despite rapid advances up global rankings in recent years… excess liquidity has inflated asset prices and that investments made with short-term, high-interest loans threaten the stability of the overall economy…

The general atmosphere is one that encourages speculation, and entrepreneurs have become less patient with real businesses that take time to pay off.’

So, if you still subscribe to the suggestion that the dreadful misdirection of real resources and human aspirations into the various Ponzi schemes, White Elephants, and me-too bandwagons which a credit boom inevitably occasions can be gently guided back to some sort of sustainable, income-generating, self-amortizing pathway by the omniscient hand of the very same idiots who unleashed this outbreak of mass folly—well, I have some AIG stock, some Greek government debt, and some Chinese railway bonds to sell you!

In reality, the only stay of execution the central meddlers can effect is to quit too early in the job of damping down whichever speculative blaze it is that they are belatedly trying to extinguish—a course which only reinforces the associated moral hazard and so encourages even more edge-of-the-waterfall foolhardiness when next it flares up again.

The somewhat less palatable—if neatly exculpatory—alternative is to allow the implosion of the current frenzy to proceed to its awful denouement relatively unhindered, while identifying likely candidates for a new bubble to be pumped up amid the ruins of the old (ideally laying the foundations for this replacement Babel while the masonry is still tumbling from its predecessor).

Keynesians might just recognise that this describes the remedy they usually prescribe when they talk of the social imperative to maintain ‘aggregate demand’ by inveigling whichever groups still possess the simulacrum of a decent balance sheet to ruin it in their turn by spending more than they earn on things which will never help to repay the greatly increased indebtedness which must inevitably accompany such a policy.

A classic case in point here was the openly avowed intent of Messrs Greenspan and George to have householders and governments put their futures in hock as an offset to the collapse in corporate exuberance entailed by the TMT crash, a decade ago. We all know how well THAT worked out!

China, however, has chosen not to heed the evidence before it of the inadvisability of such a programme—or else it has come to rely far too heavily on the overblown opinion we credulous gweilos hold of the Party’s omnipotence. China—and several of its Eastern neighbours—have turned a blind eye to the Japanese experience of the late 1980’s; have ignored the lessons of the disastrous Tiger hunt of the late 1990s: and have paid no attention to Korea’s succession of failed experiments in issuing every citizen with a multiplicity of credit cards and/or encouraging them to dabble in the property market every time the local chaebol find their export revenues threatened.

Indeed, an Asia (strictly, a broader EM grouping) to  which everyone—not just President Sarkozy—implicitly looks as the saviour of their business plan, as well as of their debt crisis, may have lined itself up for a powerful double whammy. For now, the intervention-delayed and intervention-magnified impact of Europe’s post-bubble reversion is blowing a chill wind through an arguably overbuilt export sector at the same time that the scope for another, mighty,  internal boost has been greatly lessened for fear that even greater destabilization takes place and that further, socially-invidious side effects are inflicted upon a long-suffering populace at home.

Among these latter are not just price inflation of a whole host of necessaries—with all the implications that has for the quality of life—but also the rampant cronyism and outright corruption which are the inescapable concomitants of a system where fallible men step in to ration scarce resources when dispassionate economic forces are not allowed to do so, according to the most urgently expressed uses of those trying to acquire one thing honestly by offering some other freely in the marketplace.

And if you do not yet recognise the shining Middle Kingdom of Sinophile myth in the foregoing description, ask yourself why it is that comments emanating from a recent conference of CEOs involved in China and convened by Chief Executive magazine threw up the following, acerbic observations.

Referring to the ongoing war for talent, one said:

“People are, frankly, totally underqualified for the roles they’re getting. If you can speak English and Chinese and have any Western training, you’re just constantly moving on because a lot of companies are squabbling over a very small supply of people.”

Worse yet, the tainted nature of the system has not gone unregistered. Thus, the fortunate few seem to have realised where there bread will be most  thickly buttered—and that this will not be as part of a genuinely entrepreneurial outfit of wealth creators, but in the ranks of one of the privileged creatures of the Party:

“The nature of loyalty in China is associated more with working for a state-owned enterprise than with staying with the brand where you began. In the old days a foreign company was the place to be because you were going to learn, but today they would rather work for a state-owned enterprise… As far as they’re concerned that’s where the action is and where the power will be—and that’s an issue for all of us. At the end of the day you need Chinese people working in your company and it’s going to be harder and harder to acquire those people.”

No wonder that a joint report by China Merchants Bank and Bain & Co, largely corroborated by a similar, if broader, survey conducted by the Hurun Research Institute and the Bank of China, revealed that almost half of the wealthy Chinese asked (a group defined as disposing of more than Y100 million in the first sample and of Y10 million-plus in the second) were planning to emigrate while a quarter of the upper echelon and a sixth of the lower already had. This finding was of sufficient concern that the usual Party organs were quick to respond with editorials piously proclaiming the leadership’s intent to address the many shortcomings which these select wielders of a great deal of capital stock felt were driving them away from their homeland.

China bulls, clamouring to get in, should take note that much of the smart money seems to be rather anxious to shake off the dust of the place, instead!

Back in the Grand Guignol which is the European Union, it is hard to know where to start—and even harder to keep up, as life not only imitates art, but frequently surpasses it with every screen refresh of the modern 24/7 news cycle.

One feature among this whirl of comment and counter-comment which does exercise your author is the irritating penchant for talking heads and gurus manqué to adopt the soundbite of the moment and then to repeat it mindlessly as if it were some profound coinage of their own.

‘Kicking the can down the road’ is a particular disfavourite of the moment, but at least its overuse is an easily forgivable lapse for those speaking impromptu, if not quite so pardonable for those writing and having the benefit of a second look at what they are saying.

But the one that really gets one’s goat is the mindless mantra of ’no monetary union without fiscal union’ since this is not only larded with an ersatz gravitas, but actually propounds a false economics. Worse, it insinuates a Bernaysian programming into the user’s mind in favour of the gross imperialism espoused by the worst One World Government vipers in our nest.

In truth, this infernal mantra is a complete canard which perhaps deserves a moment’s further examination.

When you and I, as neighbours, do business with one another, we are effectively co-members of a monetary union, too, yet we seem instinctively to manage without ever having to agree to pool our household finances—that is, to engage in an interpersonal fiscal union—as a way of ensuring that we can both continue to accept the same medium of exchange.

So, if it works for individuals, why is it any different if one clan trades with another, or one village, one canton—or one whole nation?

Can we not be honest enough to stop parroting this latest Newspeak which the bien pensants have cooked up in order to serve their masters’ hidden agenda and to say, candidly, that:

‘It is highly likely that the European leadership will chose one of the two, following alternatives, since they believe these to exhaust all possible ways of trying to address their self-inflicted problems.’

‘One, they will engage in the OVERT fiscal union of a federal budgetary control exercised far from the scrutiny of the concerned citizen—even though this may be in contravention of the rule of law and will undoubtedly take place absent any democratic mandate; or, two, they will indulge in the COVERT fiscal union of massive, central bank inflation injected via the indiscriminate purchase of government bonds, weighted to those IOUs issued by the most abject profligates, the one responsible for getting us into this mess in the first place’

The first, the irresistibly acronymic FU, is presumably the elite’s first preference since it suits the collectivist dream which informs the whole project of erecting an Unholy Roman Empire (or an EUSSR if you are even more cynical) – and it also reduces the scope for the sort of tiresome, bottom-up, locally-chosen, social arrangements to flourish within each of the national polities, different visions which might therefore compete within the Union—a central planner’s nightmare, if ever one existed!

For the second, that also speaks to the mainstream fetish with top-down ‘fixes’ and also with the (non-Teutonic) boys’ room envy of the unfettered Fed which undoubtedly prevails in the dark corridors of the ECB. So, at some point, this could well become a complement to the former approach, if only over the metaphorically dead bodies of a few more Bundesbankers.

Note, however, that if Snr Draghi emulates his ineffable predecessor in office and adds meaningfully to the size of the ECB’s balance sheet expansion and to its credit exposure, it may quickly require a near-consummate degree of FU to backstop it in any case.

If asked to opt for a choice, we think this latter is still a second choice—if an achingly tempting one— since it raises a host of opposing issues far too emotive and far too easily sound-bitten to be palatable to a German electorate which must be lulled or scared into acquiescence with the power transfer and with their implicit underwriting of most of the associated costs (witness the recent furore over a putative IMF smash’n’grab to replace Buba gold with JMK’s SDR dross).

Just this last week, there has appeared—almost out of nowhere—the kernel of an idea of following a third, previously unthinkable route: viz, that of pushing the recalcitrants and the feckless out of the single currency, if not out of the Union itself.

Transitional difficulties aside, this is almost something we would be inclined to endorse as a lesser of many evils were it not for the sneaking suspicion that it is nothing more than a gambit aimed at scaring the ne’er-do-well, Latinate nephews with the prospect that their stern, Northern European, maiden aunts might not continue with their allowance if they do not promise to do better in future. Time will tell.

Which particular road to perdition is followed is still very much moot at the moment, but while we wait to be informed of the choice, we might while away the time in contemplation of the fact that the deliberately constricted menu which the world’s leaders have set before themselves does not actually list all the available options.

Just as a completely whimsical Gedanken experiment—with no practical relevance in the world as it is today, alas—let’s just suppose that we write down/off the Greeks’ (and all the others’) insupportable sovereign debts; that we shut those among the 7000 (sic!) extant EZone banks which can’t cope with the reality check; that we recap those who can, but who are now impaired—by appeal to private means for strong preference. Then, the Augean stables cleansed, we then insist on a proper degree of sanitation, henceforth, meaning that we balance budgets by reducing government spending to a bare minimum while kick-starting growth through offering (generalized and simple, not falsely-ingenious and dirigiste) tax incentives to promote entrepreneurship and to foster capital formation.

This latter may never, ever fly among today’s global Jacobins, but that’s not to say that we cannot wonder whether such radical thinking might point to a way out of the false dichotomy posited by the powers-that- be. Nor, even if we wearily admit defeat as a matter of pragmatic politics, do we have to deny ourselves the chance to offer up a critical analysis of the half-truths and quack thinking they are offering up as a rationale for their blind Flucht nach Vorn.

The dismissal of the platform encapsulated in the shibboleth of ‘no common money without a common treasury’ is a classic case in point. What do those who solemnly rehearse this formula think happened during the long millennia when real, tangible, specie money flowed freely across borders and between sovereignties everywhere?