2011 – The year when
money starts to die
Between 1716 and 1720, John Law
tried to rescue the French government from bankruptcy
with a scheme that came to be called “The Mississippi
Bubble”. His strategy was to set up two entities: a bank
whose purpose was to issue paper money, and a company
whose primary but undeclared function was to refinance
government debt. Law realised that he had to confiscate
all gold and silver other than smaller quantities, and
force French citizens to pay their taxes and buy shares
in the Mississippi Company, only with the bank’s newly
issued notes. These were the three essential elements of
his scheme.[i]
This is precisely what central
banks in the US, Europe, Japan and the UK are doing
today. They are rigging the markets by buying government
debt at artificially high prices with freshly created
paper money, having previously excluded gold and silver
from any role as legal tender. The following quote from
John Law, could equally be attributed to a central
banker of today: “An abundance of money which would
lower the interest rate to two per cent would, in
reducing the financing costs of the debts and public
offices etc. relieve the King.” This is quantitative
easing, pure and simple, and John Law had fully
anticipated modern central banking. Law’s scheme ended
in disaster and as a precedent for today’s central
banking this should worry us greatly.
Many of us recognise the government
debt bubble, which ensures that today’s rulers are
relieved by the artificially low cost of their debt.
But most of us are unaware of the other bubble, that of
the value of money, which is also held up at
artificially high levels. The money bubble is inflating
primarily in quantity rather than price, making it
easier to deceive the public. There is also a
fundamental difference from the usual bubbles, which end
with a collapse while money’s value is unaffected: in
this dual bubble both debt and money will
eventually collapse together; the former as nominal
yields rise and the latter being reflected in rising
precious metal prices.
In Law’s time, it was made illegal
to hold more than a minimal quantity of gold and silver
coinage. Today the central banks have had a different
approach, removing gold and silver from circulation
altogether. Naturally, central banks have also
convinced themselves that precious metals are now
redundant, fully replaced by paper money, so they have
carelessly reduced their own holdings to suppress
prices. At the same time commercial banks offering gold
and silver accounts have developed large uncovered
liabilities with their customers through their
fractional banking practices. Through these uncovered,
undeclared positions, the strategy of depressing bullion
prices has become dangerously dependant on confidence
remaining in both the central banks and the banking
system.
We can expect the collapse in money
values to be reflected in gold and silver prices rather
than other paper currencies, and the warning signs are
now upon us. Bullion has been climbing in value for a
decade, and in 2010 buyers found it regularly difficult
to get physical metal delivered to them by the banks. It
is becoming clear that the ability of the central banks
to keep a lid on bullion prices is at last coming to an
end.
And it is not just bullion prices
getting out of control. In the last three months the
yield on government debt has risen in spite of fresh
rounds of monetary inflation. Markets are now becoming
wary of future currency issuance to support the
government bond markets, and they are beginning to
question risk, rather than value stability. We are
learning how it must have felt in Paris in the early
months of 1720, when the Mississippi Company share
price, as proxy for government debt, began to fall. And
if the last few months of 2010 marked the beginning of
the end for today’s government bonds, this new year of
2011 will mark the beginning of the end for paper money.
The two bubbles are now fully interdependent.
This is why we might call 2011 the
year money starts to die. The central banks are
beginning to lose control over bubbles one and two, and
also bullion. The destruction of private sector savings
has coincided with expanding budget deficits so the
expansion of the money bubble will have to continue to
contain the situation, because there is no alternative.
As monetary inflation translates into price inflation,
government bond yields will rise again, developing into
a self-feeding loop of government bond prices and
currency purchasing-powers falling, as the prices of
commodities and raw materials rise further. This process
is already underway.
Rising price inflation should lead
to rising interest rates, which will be unwelcome to the
bubble inflators. Higher interest rates will wreck what
is left of government finances, and lead to substantial
losses for the banking system as well, due to the impact
on the economy and asset prices. Suddenly, there will
be negative feedback loops everywhere. That is what
John Law discovered through the summer of 1720, and it
is safer to expect history to repeat itself than not.
This time, the implosion of
government debt and paper currency values will not
be confined to the destructive popping of the Mississippi
bubble. The bubbles today are global and taken together
are far bigger. The values of specie are greatly
suppressed today[ii],
which was not the case in John Law’s time. The
adjustment, when it comes, should be far sharper, even
catastrophic as a result, and the loss of confidence
sudden. It will confound those who trust in a
mechanistic link between the quantity of money and the
general price level. It will wreck the Keynesians’
cherished experiment with expanding deficits as a means
of economic regeneration. It will destroy the central
banks. It will be a poor consolation that these last two
consequences will at least be a pyrrhic good.
Now, the New Year, reviving old
desires, the thoughtful soul to solitude retires. It is
the time for investment strategists to dream their
forecasts, which are invariably optimistic. But there is
only one question to ask of these soothsayers, and that
is the fate of the two bubbles, and the suppression of
gold and silver prices. Will it all unravel in 2011?
Maybe, but if money does not
actually die this year, this is the year money starts to
die.
5 January 2011
[i] The
financial aspects of the Mississippi Bubble are
best described in Douglas French’s book,
Early Speculative Bubbles and Increases in the
Supply of Money, published by the Mises
Institute.
