The Most Misunderstood Threat Of Economic Implosion

Readers turning to alternative news sites often try to explain their concerns with others (friends, family, colleagues, business partners). Empirically we know that most people understand that “something is wrong” but they fail to understand the real underlying threats of our economic system. The real risk is inherently related to our monetary system, a topic that is not understood by the majority of people. There are even no classes at university researching the monetary system and monetary history.

Even economists seem to have a hard time understanding and agreeing on how monetary issues and policy impact the economy and markets.

An example of this is found in a compilation of TV appearances by Peter Schiff going back to 2006 and 2007 (between 29m03s and 40m). In it, one of the economic commentators starts laughing when Schiff argues that “the absence of lending standards” will lead to a “tightening of credits” which would be the cause of a collapse in the markets (scroll to 32m in the video). Small detail: this was a couple of months before the start of the worst financial collapse in history.

Another example is in this Q&A between Rick Santelli and Noble prize winner Eugene Fama. The Noble laureate argues that shrinking a central bank’s balance sheet is a “neutral event.”

Of course, it goes without saying that the “heavy weight experts” like Paul Krugman argue that much more monetary stimulus is needed. They think there is not enough economic progress because “not enough has been done,” which is an easy way to anticipate failure of course (but not admit it).

Apart from economists and economic observers, more so the general public has a misunderstanding of the risks of the monetary system. Case in point: the Occupy Wall Street movement. Peter Schiff tried to explain the protesters that Wall Street is not the issue but rather the banking industry and the centrally planned system (source). His efforts had not much success.

Readers who have an interest in precious metals or own them, even after the crash of April / June 2013, are likely to understand that there are two theories which explain monetary matters (or fail to explain). Austrian economics take the monetary system and policies into account as a potential risk, while Keynesian economics do not see a risk. Readers acquainted with these schools of thoughts can skip the following chapter and move on to the next ones. Readers who are not familiar with the consequences of monetary stimulus should first read the following chapter.

The central problem

Noble laureate Eugene Fama pretends that contracting the monetary base (the central bank’s balance sheet) is a “neutral event.” From an Austrian point of view, that does not make sense at all. Why? Because centrally planned expansion of debt based credit leads to economic bubbles. Excessive credit creation along with artificially suppressed interest rates lead to imbalances between investments and savings. In fact, it stimulates malinvestments. The housing bubble was the most recent manifestation of that dynamic.

In a world with no limitations on the expansion of the money supply it is to be expected that a centrally planned expansion (boom) will be followed  by a contraction of the money supply (bust). From that point of view, a shrinking monetary base (central bank balance sheet) will of course have a significant impact in the real world.

Apart from economic theories, one could look at it in the most simplistic way: if monetary easing was invoked to have a real result (i.e. economic growth) then it implies that removing monetary easing will have the reverse effect … otherwise why was it invoked in the first place? That’s plain logic.

Recent research shows that today’s Monetary System Is Responsible For The Growing Inequality and it concludes that “it appears that several factors contribute to the growth of inequality, but at the heart is the operation of the banking system. To resolve inequality, it is mandatory to change the way money is created.

Also history provides confirmation of the central thesis that monetary expansion is risky and, potentially, a very destructive business. In Real vs False Money – Key Insights From Monetary History we published some excerpts from Claudio Grass his research note:

Governments have a track record of diluting the value of their currency. History is full of examples where governments started mixing worthless metals into gold coins as soon as they ran into financial trouble.

Banks and governments have been acting as an “alliance” till this day because the fractional system benefits both. Why? Because governments give the banks the right to “print money”. In exchange, they expect the banks to buy their bonds (which is nothing more than debt) so they can continue to spend money which they simply don’t have.

The central problem is of course that today’s monetary system suits the needs of the government. It allows for maximum intervention and control. It benefits its participants and allows the continuation of the “alliance” with the banking industry. The establishment that has been created is huge; its participants have a vested interested to keep this system going.

Of course, Noble laureats and theorists associated with “the establishment” do not have anything at risk. They are no entrepreneurs and are not directly impacted by the destructive effects of monetary policies. They can continue their work-as-usual, also during a crash, as “the establishment” needs them. So why should they stop defending their theories?

There must be a reason why Richard Cantillon’s Essay on Economic Theory (written in the 18th century) and Ludwig von Mises his Theory of Money and Credit (written in the 20th century) are never quoted by the Keynesians. It is no coincidence that those books explain in great detail how money is NOT neutral.

Desperation or incompetence?

Given the destructive effects of monetary policy, which have been repeated again and again in history, one should rightfully ask why the biggest monetary stimulus ever keeps on continuing. After all, as Mike Maloney (host of Hidden Secrets of Money) demonstrated in his latest educational video, the money museum at the Bundesbank in Germany exhibits the following quote :

In the twentieth century, uncovered currencies have been the norm. In principle, the money stock could grow unchecked. This is why central banks must ensure that the money stock is in line with economic growth.

The shape of the economy is not good, which is in sharp contrast to what the mainstream media wants us to believe. Things are probably so bad that removing monetary stimulus will result in an outright implosion. The next chart shows to which extent the monetary base M0 (blue line) needs to be expanded by the central bank in order to have the money supply M2 (red line) growing at a “normal” pace. There is something fundamentally wrong with this picture. The data are US only.


So central banks are supposed to know the risk associated with the expansion and contraction of the money supply. Are they incompetent? Most likely not. They have a vested interest in “their system” and must defend their positions. As Nomi Prins points out, the core objective of the US central bank is to help the banking industry:

Nearly 10% of the residential mortgage loans of the Big Six banks are non-performing. This is not very different from the 11% highs in 2009 (compared to smaller banks whose ratios are 3.5% vs. 6% in 2009). In other words, the Big Six banks still hold near record high levels of bad mortgages, and in higher concentrations than smaller banks. That’s why the Fed isn’t tapering, not because it’s waiting for a magic unemployment rate.

Besides, there is hardly empirical evidence of a correlation between monetary easing and employment creation. Try searching for research on that matter.

Jim Rickards takes this one step further. In his speech during the Casey Summit in October of this year, he explained how the Fed’s models are structurally wrong. He also pointed out that there is no correlation between monetary easing and employment. Last but not least, in his view the central banks are playing with a nuclear reactor while they think they are fully in control of the economy. He believes we are close to a tipping point in a “nuclear process” where there is no way back.

Can we conclude then that central bankers are desperate? We believe so. Admittedly, given the absence of results, desperation is resulting in incompetence.

Prospects: more of the same

Given the above, the outlook is not really pretty. Starting with Japan, where Abenomics have not resulted in the intended effects. Besides, there are “unintended consequences” associated with the weakened Yen. More in this analysis from Asia Confidential. One could expect more monetary easing going forward.

Competitive devaluation of currencies was initiated by the US Fed with its QE program. Japan fired back about a year ago with their version of QE, resulting in approximately a 15% devaluation of the Yen.

As announced earlier this week by news agency Finmarket, the Russian central bank is preparing “a Russian variant of careful quantitative easing.” Finmarket reports that Russian financial markets expect a devaluation of the ruble of up to 50 percent. Although the Russian central bank has spent several hundred billion dollars to strengthen its currency, the coming devaluation of the ruble is expected to lead to a boost in exports, particularly of raw materials. Obviously the devaluation will result in higher import prices, as we explained in Japan Experiencing The Ugly Effects Of Its Own Policy.

With a global competition in currency debasements, with limitless monetary stimulus, with decreasing effects of monetary expansion, with a conscious infringement of the monetary rules, it should be clear that there is hardly a way back for our leaders. Given this outlook, we believe it is a matter of “when,” not “if” the next collapse occurs.

Gold as a central bank insurance

John Mauldin said in his last interview with Steve Forbes that he sees gold as central bank insurance. “I buy fire insurance. I have health insurance. I hope I never use them. I’m particularly, aggressively working at never having to use my life insurance, although I do have it. And I hope I never use my gold insurance. But I do have some. I buy some every month. I believe that gold will prove to have been more of a store of value than putting a hundred dollars a month into a savings account that is going to be stuck in a low-interest-rate regime for a long time.”

He also explained that gold will move up when real interest rates are severely suppressed. He sees a real potential for severe repression of interest rates, judging from the latest research papers written by members of the Federal Reserve economics team. “I don’t think things change under Janet Yellen. I think we get financial repression. And we’re going to see savers and retirees screwed. We talk about the problems that pension funds face. Every 60-40 portfolio – 60% stocks, 40% bonds – is required to get something close to 9% or 10%, maybe even 11%, out of their equity portfolios from today’s valuations, because the return on their bond fixed-income portfolio, that 40%, is so low. And yet they’re so dependent on those return projections and on growth reverting to trend, because the bulk of the money that’s supposed to be in those pension funds in 30 years is not the money that’s being put in now by employees; it’s the compound growth of that money. And if the growth on that money is not there, the pension that the person thought he was paying into is not going to be there.”

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