Financial markets still don’t get it

Apologies if the title of this Schlichter-file sounds somewhat arrogant but after the events of the past three weeks I may perhaps be forgiven for feeling a bit emboldened in my views. Of course, this is often the point at which the pendulum swings in the other direction and developments take a slightly different turn, if only for a short time. After all, big trends almost never go from A to B in a straight line. So let’s stay modest and nimble. But there can be no denying that the events of that past two to three weeks have been very supportive of my views: signs are accumulating everywhere that we are in the twilight of the fiat money era. The system is fairly beyond repair. And its demise is accelerating.

I have not been following events and market debate quite as closely as usual as I have been in Italy for the past three weeks, from where I am writing this. Italy is, of course broke, but it is still a lovely place and, thankfully, so far riot-free. I should probably correct the last sentence: the Italian state is broke, the tax-funded overinflated public sector, not the individual Italians. This is a difference that the politicians and the statist media tend to ignore. Private citizens are often income producing and even wealthy and quite capable of looking after themselves. Most of them never signed up for all this state debt. It seems beyond doubt to me that the productive part of society – and thus, in the long run, all of society – will benefit greatly when the ever-growing, overspending, taxing, meddling, regulating welfare state finally meets its well-deserved demise in a string of spectacular sovereign defaults. Of course, the political establishment have a vested interest in constantly portraying their financial plight as a massive problem for the entire nation. The Swiss novelist Duerrenmatt famously said that the state calls itself “fatherland” whenever it is set on waging war. It may be added that it does so too when it is set on expropriating more in taxes, or when it debases the money in order to fund its profligate ways.

Remember, the state is not the people! Therefore, embrace default!

What we have learnt in the past weeks?

In any case, even from the comfortable distance of the sunny hills of Tuscany it is clear that the past three weeks must have driven home the following points to even the most starry-eyed Pollyanna out there:

First, this is not a cycle, at least not in the way that it is portrayed so lazily in the mainstream media. It is now four years since the U.S. subprime market nosedived. The economy’s statistical bean-counters (sometimes incorrectly referred to as economists) tell us that the recession ended two years ago. Yet, the Federal Reserve last week promised near-zero interest rates for years to come. Wake up! This is no cycle! We are not just in another economic downturn. This is not just another recession, or even – oh stupid phrase! – a double dip. We cannot say that ‘we have been here before’, and that it will just take a bit longer till we get out. ‘All this great stimulus will ultimately kick-start the economy into higher gear.’ Rubbish! We are witnessing systemic disintegration! A dysfunctional economic architecture – built on the quicksand of ever-expanding fiat money, artificially low interest rates and ever-higher piles of debt – has reached its logical endgame. This is systemic failure, not cyclical fluctuation.

Second, there is no exit strategy. The central banks are firmly boxed in. They are trapped. Back in April, when the ECB enacted its first rate hike and the market commentary was awash with predictions of a coming tightening cycle, I wrote Don’t believe the hype! Why the ECB rate hike doesn’t mean anything. Don’t be fooled by some verbal sabre-rattling and some cosmetic rate adjustments. The ECB cannot and will not remove monetary accommodation. The balance sheet of the central bank will not shrink. It will grow. The ECB will not be allowed to pull the rug from under the European banks and governments. Banks and states can sustain the mirage of solvency only with the help of the ECB’s printing press. I also predicted that the ECB would buy more government bonds. All of this received ample confirmation in recent weeks. The ECB’s statement that it does this to maintain liquid markets and to effectively conduct its monetary policy is such a laughably thin-veiled attempt at keeping face that it borders on insulting our intelligence.

Paper money systems are always creations of the state, and fiat money is always a tool of the state. Hence, ‘central bank independence’ is always an oxymoron but never more so than when the paper money inflation is reaching its tipping-point and the printing press becomes the last line of defence against sovereign default and bank collapse.

Even the U.S. Fed, among the major central banks the most enthusiastic monetary inflationist and blower of bubbles, a few months ago enjoyed a brief spell of openly contemplating a return to tighter money. That moment has clearly passed. After the events of July and early August, we know that Wall Street will now have to be continuously funded at zero cost, and that QE3 is practically around the corner.

Third, it is now all but official that the major states are bust. Public finances are firmly beyond repair. The modern state – legitimized by electoral majority of the one-man-one-vote type and endowed with the privileges to tax all income generators in its territory and to print money without limit – cannot live within its means, it cannot shrink and it cannot save. It is destined to become ever bigger, until it chokes on its own inconsistencies. If you needed any evidence it was provided by the childish theatre of the U.S. debt-ceiling debate, the outcome of which had never been in doubt. U.S. politicians agreed with themselves that they were not broke and that they could spend more. Anybody surprised? The so-called spending cuts that resulted from all those tough negotiations are simply a bad joke. The U.S. state machinery has casually accumulated another $ 2.7 trillion in debt over the past 2 years, yet those at the head of this out-of-control Leviathan now give themselves 10 years to cut a mere $2.4 trillion from the ever-growing pile of liabilities. How can anybody outside Planet Washington take this nonsense seriously?

I hear that S&P is getting a lot of flak for cutting Uncle Sam’s credit rating. And they should! AA+? What are they thinking? That is still way to high! U.S. government finances are simply out of control. Not only is Washington unable and unwilling to repay this debt, it will not even manage to stabilize it. By the logic of the modern democratic welfare state, ‘saving’ means spending less than one would like to and has previously decided to.

So, to summarize, there is no recovery, no exit strategy and no fiscal stabilization. Debt accumulation continues, increasingly funded via central bank debt monetization. The system staggers on, increasingly relying on the printing press. Needless to say, I feel entirely vindicated. I may also add that this is just the beginning.

Continue reading at Paper Money Collapse.

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16 replies on “Financial markets still don’t get it”
  1. I flatly disagree with the above claim that the US is “unable” to pay its debts. I don’t see the problem.

    First, if the US has issued or incurred more debt than US citizens and the world at large wish to hold, how come the yield on this debt is at a miserable near zero level? It is currently below the US inflation level. People are institutions are falling over themselves to buy this debt! Much the same goes for the UK and various other countries. Obviously, and in contrast, European PIGs are in a different category.

    As regards the idea that the US is “unable” to pay its debts, repaying such debt is a doddle, and can be done by a combination of two implements. First raise taxes and use the money to repay (or cease rolling over the debt). Second, print money and repay / cease rolling over. The former is deflationary, and the latter is stimulatory and/or inflationary. Combine the two in the right proportion, and the net effect is neutral, i.e. there’s be no effect on total numbers employed, etc

    Of course there are POLITICAL PROBLEMS in doing the above. In particular, the average economically illiterate citizen would object to the extra tax because they’d claim the tax would make them worse off. But then it’s been shown by various surveys that the average citizen wants government to do more at the same time as not wanting to pay more tax to fund such extra government activity. In other words the average citizen has a gap between the ears.

  2. says: Jim Cheoros


    Why is yield on US debt almost zero? Well, even if we discount such ‘conspiracy theories’ as central banks themselves keeping yields low by anonymously buying treasuries through ‘private’ offshore trusts, or indeed, just buying them outright (as in QE), we have at present a wildly volatile stock market and people are buying treasuries out of a misguided – and almost certainly transitory – ‘flight to safety’.

    Meanwhile, slightly more monetarily aware individuals are pushing the price of gold above USD$1800/oz as I write… we can only speculate how long it will be before the people buying treasuries start comparing their likely returns with gold and come to the obvious conclusion they’ve been sold a pup.

    Printing money to pay debt, while increasing the tax intake, would still be inflationary, unless the taxes weren’t spent. For the monetary base to remain constant, the US treasury would have to pay back the Fed exactly the amount the Fed was creating to pay off the debt in the first place. Given that the US government is spending $3.46 for every $2.16 it raises in tax (2010 figures, wikipedia) government spending would drop off a cliff.

    Yes, the debt could be paid off… if the US eschewed democracy and introduced draconian taxation. As there would almost certainly be violent insurrection if the former occured, the latter is equally unlikely.

  3. says: Rob Thorpe

    Printing money to pay debt, while increasing the tax intake, would still be inflationary, unless the taxes weren’t spent.

    That depends on your definition of inflation. If it’s money inflation we’re talking about then yes, if it’s price inflation then it depends on other things too.

  4. says: Jim Cheoros

    @Rob Thorpe

    Printing money to pay debt, while increasing the tax intake, would still be inflationary, unless the taxes weren’t spent.

    That depends on your definition of inflation. If it’s money inflation we’re talking about then yes, if it’s price inflation then it depends on other things too.

    True… did you wish to hypothesise that monetary velocity would also be reduced in the above scenario, decreasing the pressure on prices? If so, I’m sure I’m not the only one who would be interested in see your reasoning set forth.

    1. says: Rob Thorpe

      In my opinion little of the 2008-2009 money creation in the US caused price inflation because velocity fell due to the crisis. I think continued easy money into 2010-2011 did though. The picture in Britain is much less clear because of the fall in value of Britain’s output of financial services drove inflation by increasing the price of imports. But I think it’s likely that the BoEs response was too much.

      I don’t know if velocity will fall because of the ensuing sovereign debt crisis in europe. I expect that it will in countries outside the PIIGS. In Britain though the money supply is falling, something which in a Central banking system should be countered.

      1. says: hmmm

        If the money supply in UK is falling, wouldn’t this be reflected in an appreciation of the GBP? Why hasn’t this been the case?

        1. says: Rob Thorpe

          As Toby says it takes time for changes to have an effect.

          Apart from that though the value of money is affected by the value of assets, goods and services in one country compared to others. It’s affected by imports and exports of course, but that’s closely related.

          If currency values depended only on the money supply then speculation on forex would be very simpler than it is.

        1. says: Rob Thorpe

          I’m a backseat-driver central planner, just like many of us here.

          I’m not claiming I can outperform the market as a central planner. All I’m saying is that since we have central planning in this area rather than a market mechanism some policies are better than others.

          Those who criticise QE (for example) are no different, they believe they know what the money supply should be better than the central planners who are in control.

          1. For the record, I accept I can’t plan for the economy, only the market of freely consenting adults can , like Mises and Hayek taught us. Any central bank emission of anything is a bad and should be opposed always.

      2. says: Jim Cheoros

        My understanding is that when CBs make such interventions they wind up expanding M0. This may or may not feed into prices in the short (or even medium) term. But the problem is, if the economy does start to pick up (the whole point of these interventions, supposedly), then velocity starts to pick up as well, at which point it’s difficult to contract M0 back again. Looking at a graph of US M0 for the 50 years preceding 2010:

        it’s clear there have been few occasions when M0 has been contracted. They’d have to raise interest rates in an attempt to keep price inflation in check, which, in the current climate, would immediately trigger worldwide defaults. So if the economy picks up, we’re faced with them either raising interest rates, and strangling the recovery, or inflation. It’s seems pretty obvious to me which they’ll choose.

        1. says: Rob Thorpe

          They may choose not to raise rates, that’s true. We’ll see.

          But, I’m not prepared to condemn them for what they’re doing at present on the basis that they will fail to do something else later.

          1. says: Jim Cheoros

            I’m not condemning them for what they may or may not do in the future, either – I’m condemning them for doing what they’re doing now, because of what it will inevitably lead to in the future.

  5. says: Craig Howard

    Those who criticise QE (for example) are no different, they believe they know what the money supply should be better than the central planners who are in control.

    Some, perhaps. Most of us here prefer to see the markets decide what the money supply is. Back-seat planners and central planners are just voicing opinions.

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