₿oogaloo
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There are plenty of petrodollars parked overseas. There is already enough base money out there for a hyperinflation — the dollars have already been printed. The only thing required is a spark, a loss of confidence. Meanwhile, as more and more credit money gets converted to base money, the Fed keeps adding more tinder.
Diogenes, as I gaze into my crystal ball, here is what I see… two alternatives, but with the same result. In the first alternative, the gold market freezes up first, perhaps in connection with a political event. The result is a collapse in the monetary plane as physical gold becomes the only refuge and the currencies suffer a loss of confidence and hyperinflate. That could be the event that overcomes the present inertia.
The second possibility reverses the sequence. The currencies hyperinflate and trigger the rush into bullion. Only a small handful of people thought it conceivably possible that the dollar could hyperinflate and were predicting that outcome in September 2008. Now the view is more widespread that it is at least possible. Watch what happens if there is another deflationary swoon. If that happens, you are right, there’s all that unrepayable debt. But it will be repaid in nominal terms. The lenders will not lose a cent as all those bad debts become converted to base money. Historically money came into existence in the form of debt, but in a deflationary envirornment it is as you say — nobody wants to take on new debt. So base money becomes a much higher percentage of the money supply. As that process continues the Fed and other central banks lose more and more control. At some point velocity can and will change direction immediately. I am not looking for a gradual change. I am looking for a sudden reversal that will become unstoppable. You speak of pundits making such predictions for the last six years as if six years is a long time. But is it? For someone watching the pot waiting for it to boil, six years seems like an eternity. But the water will boil. It’s the only possible outcome.
Given the policy response from and after 2008, this had to happen. With interest rates at zero, all the pension funds will collapse unless we see nominal increases in asset prices, — and the only way to see nominal increases is for the central banks to be the buyer of last resort.
This will go on until the system resets. What will that look like? I don’t think it will be as bad as many fear. I expect a rush into physical bullion at some point, possibly precipitated by the PBoC and/or the Russians openly bidding for all available bullion (which might be triggered by a political event). That will collapse the futures market and lead to a week long banking holiday worldwide. The central banks will save all debt in nominal terms as all currencies will hyperinflate, but in real terms the debt will crash. Much of the world will resort to a barter economy for three months, but that will be short lived. Gold will resume trading at a significantly higher value and will de facto replace the dollar as the reserve currency (along with oil), but without a return to a fixed exchange standard. The dollar will become like the peso. It will continue to exist, but its purchasing power will be only a tiny fraction of what it is today. And after three months the world financial system will become stable again and we will “start over” in a whole new world financial order.
Diogenes Shrugged: Kunstler had a piece a few weeks ago for people with self doubt whether they were crazy to continue believing in collapse. As I recall, he said two things keep the system going: fraud and inertia. I think the key, really, is fraud. What turned around the markets in March 2009? The change to the FASB rule that allowed banks to mark assets to whatever value they wanted. That was the turning point. That made it all but impossible to evaluate the solvency of the banks. Combine that with Black’s analysis and I have no doubt in my mind. If you don’t punish fraud, that guarantees that people will game the system. They will game the system until there are consequences. That’s elementary human nature. If the consequence is not jail, the consequence will be collapse.
Raul, thank you for the response. What then is the end game? I always thought of your site as warning of a deflationary outcome. That also seems to be the message that others get too. By a deflationary outcome I mean a deflationary crash -> civil unrest -> war? -> reset to a no-growth economic system. But in a hyper inflationary sequence it could go deflationary crash -> civil unrest -> currency destruction -> reset to a no-growth economic system with a monetary reset too (from a debt based system to an equity based system). Although these sequences are very simplistic and there are many variations, I think it is foregone conclusion that the latter theme is the 99% likely outcome. I think Japan only survives for now because the entire global system is interconnected with a lot of duct tape. Do they become the first domino? Or does the whole system come down together?
Although I have been following this blog for years, I just registered and posted my first comment yesterday. Thank you to Raul and Nicole for your tireless efforts.
I have a question about today’s post, and specifically the words: “that is fully due to QE, which won’t last forever” — my question is “Why won’t it last forever?” As I see it, the only reason that QE is being cut back is so that the Fed has at least one arrow in its quiver (more QE) when the next wave of loan defaults comes rolling in. The response of course will be QE ad infinitum until the system breaks. The System MUST grow, and if it cannot grow in real terms then it WILL at least grow in nominal terms, and let the chips fall where they may when the real and the nominal go their separate ways. Austerity leads to revolution and violence. QE is the path of least political resistance. Yes, in real terms we are at the end of growth. But in nominal terms we are all on the road to becoming trillionaires.
Diogenes Shrugged, I do not expect a return of “animal spirits” after the banks are made whole, at least not in the sense of a return of the appetite for banks to lend and borrowers to borrow. Instead, I expect a series of cascading defaults that carry over into derivatives, and make the scale of the defaults far greater than they were in 2008. All of this will be papered over just like before, only this time with a much larger increase in base money creation. As you say, the Fed’s balance sheet is already a disaster, so another tsunami, and bigger tsunami, will ultimately cause a loss of confidence in the currency. When do we get there? I cannot tell you that. But I can tell you this: The defaults are coming and the Fed will continue to bail out the banks until we reach the point of that loss of confidence.
Koso_Man, I cannot speak to the “next correction” but for the final end game (whenever it comes) I think it’s one of two scenarios: deflation or hyperinflation. In the deflation scenario we see austerity, widespread defaults, civil unrest, the government killing its own people, debt servitude, lenders trying to squeeze blood out of every last turnip, pension cuts, social security cuts, and the process dragging out for what seems like forever. In hyperinflation you get basically the same thing for a long time, up until the point the people rise up and the government caves in. The government buys all the bad debt, restores all entitlements in nominal terms, and everything goes up in nominal terms, which is a whole lot easier to handle psychologically — even if the end result is the same. It is the only possible end game IMO. Though how we get there and how long it takes I cannot say.
Diogenes Shrugged: I agree with you right up to the very end. That’s where I see the Federal Reserve buying all of that failing debt for cash, 100 cents on the dollar, the currency be damned. That will be seen as the best way to alleviate the social unrest, and the banks will be happy because they will be the first in line to receive all that newly minted cash. The “helicopter” promise was a lie all along. Ben was never going to drop the money on the masses, though as Steve Keen argued, that probably would have been a whole lot more effective.
If interest rates stay close to zero, then asset prices need to keep going up at 7% per year. Otherwise the pension funds go bust, and that can never be allowed to happen. On a nominal basis this means policy makers will make sure that everything keeps going up. If credit collapses they will keep the game going with base money. The deflationists are right, right up to the very end, and then they get it wrong. Politically, deflation (and by this I mean a deflationary spiral and not the deflationary hiccup from 2008) is unacceptable. Policy makers will choose a hyper-inflationary reset every single time.
All money is borrowed into existence, except for physical cash, which is a tiny fraction of the money supply. If the debt money system collapses through cascading debt defaults, the asset values of everything must drop to (practically) zero. That is why there is zero chance that the experiment ends this way — and why there is a near 100% chance that the experiment ultimately ends in hyperinflation/destruction of the currency.
