Free Markets, Free People

Worst-Case Scenario

Ever since the Fed began the first round of what is now called Quantitative easing, massively expanding the money supply, I’ve been worried about what would happen when demand began rising, and the Fed had to somehow try and draw all that extra cash out of the economy before it became inflationary—or even worse—hyperinflationary.

That’s still a worry for me, because I have, let us say, less than absolute confidence that Chairman Bernanke and his colleagues can pull that monetary sterilization off without a misstep.

Happily, that is becoming a secondary worry for me. Unhappily, that’s because it’s been replaced by a new worry, articulated by Paul Brodsky, bond market expert and co-founder of QB Asset Management. Mr. Brodsky maintains that the real inflationary danger lies elsewhere. I mean, it still lies at at the Fed and other Central Banks, but for a different reason.

The world has simply gotten itself into too much debt. There are creditors that expect to be paid, and debtors that are having an increasingly difficult time making their coupon payments. No amount of political or policy intervention is going to change that reality. (Unless a global "debt jubilee" transpires, which Paul thinks is unlikely).

Looking at the global monetary base, Paul sees it dwarfed by the staggering amount of debts that need to be repaid or serviced. The reckless use of leverage has resulted in a chasm between total credit and the money that can service it.

So how will this debt overhang be resolved?

Central bank money printing — and lots of it — thinks Paul.

The problem has been exacerbated by the fact that, when faced with an economic depression brought on by the collapse of a debt bubble—mainly in mortgages—the preferred policy solution pushed by governments all over the world, has been to try and re-inflate the debt bubble via stimulus spending. That is to say, overcoming the collapse of the mortgage debt bubble by creating a new, even bigger, sovereign debt bubble.

We have a pretty good idea of how much money there is in the world. We also have an idea of how much debt there is, from the sovereign debt of the united states, to credit cardholders in Finland. And it appears that there is not enough of the former, to pay off all the debts contained in the latter. If so, then that means a lot of banks—perhaps most of them—are in trouble. And we can’t have that.

What policy makers do not want to see is bank asset deterioration. That would lead to all sorts of bad things. You would see banks fail. You would see bank systems fail. You would see debtors fail and it would just feed on itself in an accelerating fashion. And so monetary policy makers have no choice but to deleverage in the other way, which is to colloquially print money; to manufacture electronic credits and call them bank reserves.

And to the degree that that extends into the private sector where debtors begin to fail en masse, that would increase failures of the bank assets in turn. And it would end the mortgage bond securities market, for example, and the leveraged loan markets, and end the private sector shadow banking system. So it does not work for anybody to have credit deteriorate. The only way to deleverage an economy is as we are saying: to create new base money with which to do it.

In other words, if central banks want to prevent entire banking systems from failing due to the collapse of the debts they hold as assets, they have no choice but to ensure that there is enough money available for everyone to meet their debt payments. To do that, they have to start printing out long sheets of beautifully engraved C-Notes. This will, of course, lead to massive inflation that will allow everyone to pay off their mortgages for the cost of a nice hat, while, at the same time, destroying the value of the world’s life savings.

This will clean up everyone’s balance sheets, and allow the world to create a brand new monetary base—let’s call it New Dollars—which, central banks having learned their lessons, will be impossible to over-borrow or inflate.

Hahahahahahahahahahahahaha! Woohoohoohoohoo! Hehehehehehehehehe. Heh heh. Ahhh. Sometimes I kill myself.

I’m just kidding with you. Seriously, they’ll try to start a new fiat currency that they’ll borrow on and debase until it collapses on our grandchildren, and screws them, too.

Dale Franks
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18 Responses to Worst-Case Scenario

  • And now I need a drink. Thanks.

  • And I vote we call the new money the “Nuyen”…

  • I have been saying this for some time. The way that governments will deal with the debt is through partial default and inflation. That is why I took a tidy profit in half of my gold, but I held on to the other half. I probably have too much cash right now, but if I see inflation starting to accelerate I will buy some other assets real quick.
    It is all going to hell in a handbasket. And I think that a Romney Presidency would certainly be a help because all of his economic policy positions seem sound, but we might be too far gone for it to matter much.

  • There are things about zerohedge I loathe, for example it’s readiness to dive into conspiracy theories which aren’t supported by their facts, and which no facts uniquely support.  They have facts consistent with the conspiracy theories, but which do not require the conspiracies–and for which there are other, simpler explanations.
    Exactly what needs to be done to force the bankers who’ve made bad loans from either going to a tent in the National Forest to live–or self defenstrate, I don’t care which–and forcing the shareholders on the board who should have exercised better oversight, to take their lumps.
    Yes, I know their pain is our and my pain, to the extent it impacts my savings.
    But if my savings are being kneecapped anyway, I’d like to see the blame directly and accurately assigned.
    Which yes is to the government, but their catspaw?  Banking executives, board members, shareholders.

  • The grand experiment of the “brights” with massive government power, “fixing” entire economies could spell the beginning of a new Dark Age in the world.
    I doubt very much it would last long in some places.  But a lot of environmentalists would be delighted…til they starved to death or succumbed to disease.
    If we dodge that bullet, let’s go back to what works…free people, making free choices in a system of limited government.

    • So, they’d enjoy it for, what, a week before they ran out of tofu and arugula?
      Within a month large numbers of them would be one with mother Gaia, traveling around in the bellies of small furry omnivores and crows.

  • I’ve been curious how much the QE is based on printing money to buy up T-bills.  I find it really hard to believe that the Fed could ever draw that kind of money expansion down.
    I’ve seen these stories about how the Fed has 3rd party “agents” buy the T-bills from the Treasury, then 24 to 72 hours later the Fed buys them from the 3rd party agents.  This is “de facto” lower of the value of the dollar.

  • Two related points:  The ‘amount’ of money necessary to pay off the debts is only half of the equation, the other is money velocity.  If every dollar changes hands every 2 minutes, there is plenty of dollars to pay all the debt.  If dollars change hands only once every two years, there is not nearly enough.  That is why the ‘excess reserves’ the banks have at the fed are so dangerous…they have no current velocity, they have been sitting there for years in most cases, but at the the first sign of worry, they can flood the ‘real economy’ and create a significant amount of sudden inflation.  That sudden inflation at least has the potential to cause a crisis in confidence in the USD….hyperinflation. 

    The other point is the debate between whether it is ‘stock’ or ‘flow’ that matters.  The Fed declared itself firmly in the stock camp, but I think reality has been proving them wrong for a few years now, and they are starting to recognize the importance of flow.  Oboviously related ot the amount and velocity conversation above.  The Fed thought by announcing they were going to buy $Xoo billion of Treasuries, that is what mattered to the market, as opposed to they were buying $X00 million per day (really per Treasury auction).  They thought the stock mattered and the flow was irrelevant, but every time they stopped buying, prices immediately started slipping, and they launched the next iteration of easing.  QE, QE lite, QE2 and Twist are apparently wearing the Fed’s confidence in the stock vs flow theory pretty thin.  Per stock theory, as soon as they announced they would, it should have been fully priced into the market, and there should have been no effect when the buying stopped…it was all known market information.  In fact what they saw was that there was no pop on announcement, but prices grinded higher during the program, and started sliding as soon as it was over.   Even they are starting to realize they don’t actually know what they are doing.    

  • The importance of the Fed being firmly in the stock camp is that is a key assumptions in their economic models.  They are starting to realize that not only do they not know what they are doing, but they were wrong all along.  But they can’t admit that….it is confidence game, and we HAVE to have faith in the man behind the curtain or it all comes apart at the seams.  If the Fed acknowledges they were wrong and don’t have good models, those hundreds of billions of excess reserves quickly mobilize, triggering a cascade that likely ends in hyperinflation/US Dollar collapse.  Suddenly. 

    • I would add here that it is precisely that sort of stock vs. flow miscalculation that led to the Fed creating the back-to-back recessions of 1981-1983. The Fed panicked at the excessive money supply growth (stock) without realizing that the velocity of money (flow) was extremely slow.

    • “They are starting to realize that not only do they not know what they are doing, but they were wrong all along”

      Not to worry. This spasm of objectivity and humility will pass. After all, they have impressive titles and letters after their names and they went to the best schools and get paid big bucks. Would they have all that if they didn’t know what they were /are doing? After all, what is the alternative? Let ignorant citizens make their own decisions?

      • Some of them have even grasped the gold ring of achieving a Nobel Prize!  So whatever they say MUST be right, right?

        • And…consider…they’ve been right all along*.
          *In KrugWorld (a division of Pixilated Pictures).