$£€¥
and the oozlum bird
Those who have been exposed to
popular Australian and British mythology may know about
the fabled oozlum bird, which flies round in ever
decreasing circles until it disappears up its own
fundament. Under the guidance of our political masters,
paper currencies are on course to disappear in the same
unusual manner.
I have
written recently about the increasing possibility of
a hyperinflationary slump: economic activity slumps,
then prices start rising at an accelerating rate until
paper currencies become valueless. To most, such an
outcome is unimaginable, except for those who lived
through Allende’s Chile or Mugabe’s Zimbabwe; and the
idea that this might happen to the dollar, euro, pound
and yen all at the same time is unthinkable.
This eventuality is becoming
impossible to avoid. For those of us not mislead by
contemporary economics it has been clear for years that
we are set on this course, and since the credit crunch,
the outcome has become more likely as events progressed.
To get off this tramline into financial oblivion
requires a return to sound money. Sound money and
“$£€¥” 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.
13 October 2010
