Wednesday, May 5, 2010

The Fiat Money End Game

Incisive commentary in this article by Michael Rozeff on the subject of how our freely floating dollar will meet its demise. He does a good job of explaining why any course other than inflation is unlikely.

Regarding the IMF/EU bailout of Greece:

"The rescue team, which consists of the stronger countries and the IMF, are damned if they do and damned if they don't. Instead of banks being insolvent with runs occurring on them as in the 1930s and 2008, we have whole countries being bankrupt, but their paper is held by banks in France and elsewhere, so there is a contagion thing to worry about. If the EU lets default happen, there is a run against all the bonds of all the weaker countries. Their yields rise, and they have to default too, and then that weakens a host of banks and others who hold the paper, and then they demand to be bailed out. If instead they rescue Greece and others, then the rescuing governments have to issue more debt, or else the IMF does too, or else the ECB gets into the act too, and this weakens the stronger countries and drives down the euro."

Basically every low interest sovereign borrower in the world is taking on an exponentially expanding debt load to bail out higher risk borrowers, private, public and sovereign, who can no longer obtain affordable credit. We'll soon reach the stage where the low interest sovereigns, the US, Germany, France, Japan, the UK, are also unable to obtain affordable financing. In light of recent debt monetization programs, conducted under the technical sounding euphemism of Quantitative Easing, one may even surmise that we've already reached that point as governments fund their deficits through central bank printing. Debt to GDP ratios in this group are already high, and rising rapidly. Higher interest rates can't be tolerated, but the only way to prevent them is for central banks to buy their own government bonds. Once a country gets on that track, as the US, UK, and Japan have recently, it may prove impossible to get off.

On why governments choose inflation:

"Faced with handling mountainous debt levels, the governments either walk away from all bondholders everywhere, this is feasible, or else they inflate and pay them off in nominal terms, or some combination of these two paths. It's these two options that we need to think through as to their effects, in order to decide which one they are likely to choose. So far, the big guys, the U.S. and Britain and Japan and probably China, have gone for inflating. They're trying not to default outright. Why? The outright default basically ends the government's ability to pay pensioners, poor people, and keep government spending up. So it revolutionizes the government itself. It ends government as we know it for awhile, and as far as politicians are concerned who have only one life to live, that's too long."

This rationale is exactly right. Politicians have power only as long as they control the supply of money. Fiat printing allows politicians to enrich whatever constituency holds greatest potential to keep them in power. Outright default robs the government of the ability to borrow, which takes power away from the politician and puts it back in the hands of the individual. That will never be tolerated.

On how this globally interconnected debt fest has survived til now:

"The only reason that the smaller countries who default (there are many, many such defaults) have survived their defaults and kept going is that the bigger countries refinance them, through their banks and through the IMF and World Bank. But there's no one who can finance the U.S. if it defaults!!! So it won't default, because of the revolutionary results of shrinking the government drastically. Therefore, of the two options, it will choose inflation."

Practically every non-antagonistic country that has defaulted over the last few decades has been bailed out in some way shape or form by the international financial community. Default has been pushed under the rug, or more accurately under the much larger heaps of debt being steadily accumulated in the developed world. The private banking system has become more interconnected, more leveraged, and less tolerant of default from any source. So governments have added it to their unpayable bar tab.

The entire article by Mr. Rozeff is a good read.

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