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Those who have been exposed to popular
Australian and British mythology may know about the fabled oozlum bird, which
flies round in ever decreasing circles until it disappears up its own fundament.
Under the guidance of our political masters, paper currencies are on course
to disappear in the same unusual manner. I have written recently about the increasing possibility of a
hyperinflationary slump: economic activity slumps, then prices start rising
at an accelerating rate until paper currencies become valueless. To most,
such an outcome is unimaginable, except for those who lived through
Allende’s Chile or Mugabe’s Zimbabwe; and the idea that this
might happen to the dollar, euro, pound and yen all at the same time is
unthinkable.
This
eventuality is becoming impossible to avoid. For those of us not mislead by
contemporary economics it has been clear for years that we are set on this
course, and since the credit crunch, the outcome has become more likely as
events progressed. To get off this tramline into financial oblivion requires
a return to sound money. Sound money and “$£€¥”
are as cosy together as church and blasphemy. In all human history sound
money has only been gold and silver, and yet again humanity will have to
relearn this lesson the hard way.
A
planned return to sound money is obviously inconceivable. It is clear
that economic recovery is fading and the slump, which is a precondition to
hyper-inflation, is on its way: a precondition not only because it is the
noun in the description, but because the $£€¥ governments tax
revenues will collapse. Furthermore welfare costs will increase due to rising
unemployment, and with revenues collapsing budget deficits will escalate
rapidly. This means that the $£€¥ governments
simultaneously need to raise much more money than currently expected.
If governments were to attempt $£€¥ funding
without quantitative easing, borrowing costs would go through the roof and
bond prices would collapse, alerting everyone to the public sector’s
insolvency.
This
is why QE is seen as vital, as vital as heroin is to a hopeless
addiction.
It
has now become apparent that reflation through deficit spending is creating
more problems than it solves, and governments will have to retrench to
protect their core welfare commitments. David Cameron realises this,
and Europe is selectively waking up to it. Ben Bernanke now realises
this, hence his warning last week in his speech on Rhode Island, that the course of public spending would either be curbed by
“a careful and deliberate process” or by a “rapid and
painful response to a looming or actual fiscal crisis”. This is very
plain speaking, even to the point of shouting, by the normally boring,
soporific Helicopter Ben. The voters in next month’s US
elections, who are increasingly sickened by government profligacy also
realise it, a message not lost on America’s politicians. So Plan B is
shaping up: we are seeing the Keynesians canned, because they have run out of
road. It is time to hand over to the central banks, which is Bernanke’s
real message.
So
it is over to the monetarists, and their analysis is broadly as
follows. To have a chance of succeeding, the primary objective of QE2
is to keep borrowing costs for governments as low as possible. It is
therefore vital to keep government bonds in a perpetual bubble for as long as
it takes. If this is achieved, then economic stability might be
preserved, and the chances of a second banking crisis reduced. However,
if the monetarists fail, a debt-deflation hell will be unleashed. This must
be prevented at all costs or it will amount to no less than the failure of monetarism.
The monetarists will not want to find themselves in the same position as the
Keynesians are today. This is why Bernanke famously concluded that as a last
resort, money will be distributed by helicopter into the economy. Deflation
will not be permitted, even momentarily.
In
this analysis the monetarists are confusing asset deflation with price
inflation. They frequently invoke the ghost of Irving Fisher, who identified
the risk of falling asset prices triggering collateral liquidation, turning
into a self-feeding financial implosion. This is asset deflation, and
printing money at best delays it. However, printing money is the precondition
for price inflation, which in dollar terms is already running at over
30% at the input level. So bizarrely the monetarists in the central
banks are making the simplest of errors, or perhaps they are turning a blind
eye. This is why with regard to inflation, the oozlum is already well
on its way to an inner darkness.
So
hyperinflation, as a result of current and prospective monetary policies has
now become a racing certainty. Investors sooner or later will wake up
to this reality, seeking protection, and their first move will be to withdraw
funds from over-priced government bond markets. Initially this is bound to
accelerate QE further as central banks attempt to support bond prices.
Perhaps at this point, the printing of money will be linked in the
public’s mind with the inexplicable rise in consumer prices, despite a
slump in demand.
The
investment alternatives to cash and government bonds are limited, which is
confirmed by the experiences from past hyperinflations. Despite
attempts to support bond markets, you cannot have zero interest rates and
accelerating price inflation. Stocks and shares will suffer: initially
they are hit by rising bond yields, and than as inflation gathers pace,
balance sheets are undermined by escalating replacement costs. Property is
also a bad investment due to the effect of rising bond yields on financially
geared assets, and because rentals always lag inflation, if you can find a
creditworthy tennant. That leaves commodities, so by a process of
elimination the money coming out of government bonds will be headed that way,
and the purchasing power of $£€¥ will collapse even further.
All
this is confirmed from previous hyperinflation episodes. Precedent tells us
it is too late to escape: the debt trap is sprung. For those that have
not properly considered these matters, a global hyperinflationary slump is
dismissed as highly unlikely. It is the ignorance of the economic and
political establishment to these dangers that is extraordinary aspect of all
this to those very few of us who have.
Alasdair McLeod
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