“When they stop buying bonds, the game is over.”

Floating currency symbols

Image by Frankie 8

I took the title for this blog from an interview that James Turk of the GoldMoney Foundation conducted with Eric Sprott, a Canadian fund manager. You can see it here. (I also recommend you have a look at this interview with Doug Casey.) I think the quote is a succinct summation of the role that the bond market, and in particular the market for government bonds, now plays in this crisis.

As you know, I would not touch bonds with a barge pole, especially government bonds. After 40 years of unending fiat money expansion, the world suffers from excess levels of debt. A lot of this debt will never be repaid. My expectation is that the market will increasingly question the ability and the willingness of most states – and that, crucially, includes the big states – to control their spending and to shed their addiction to debt financing.

What happens to high-spending credit-dependent states when the market loses confidence in them has been evident in cases such as Ireland, Portugal and Greece. Among the big financial calamities of 2011 were notably government bond markets. Perversely, some of the big winners of 2011 were also government bond markets. As I explained here, market participants have so successfully been conditioned to believe in state bonds as safe assets that when some sovereigns go into fiscal meltdown it only serves as reason to buy even more bonds of the sovereigns that are still standing, even though their fiscal outlook isn’t much better. While the fate of Greek and Italian bonds should have cast serious doubt over the long-term prospect for Bunds, Gilts and Treasuries, it only propelled them to new all-time highs. Strange world.

All policy efforts are now directed toward keeping the overextended credit edifice from correcting. After decades of fiat money fuelled credit growth, the financial system is in large parts an overbuilt house of cards. What the system cannot cope with is higher yields and wider risk premiums. Those would accelerate the pressure toward deleveraging and debt deflation and default. “When they stop buying bonds, the game is over.”

They still bought bonds in 2011

Gold Bars

Picture by Stuart Miles

2011 was another strong year for gold. Despite a brutal beating in the last month of the year, the precious metal produced again double-digit returns for the year as a whole if measured in paper dollars: up 10 percent. I believe that gold will continue to do well, as it remains the essential self-defence asset.

Amazingly, Treasuries did almost as well (+9.6%) and TIPS (inflation-protected Treasuries) did even better. German Bunds benefitted from the disaster in other euro bond markets, and they pretty much matched Treasuries in terms of total return (currency-adjusted they did less well as the euro declined slightly versus the dollar). I believe this is entirely unjustified because the EMU debt and banking woes will put considerable additional strain on Germany’s public finances. UK Gilts did better than gold and Treasuries, despite rising inflation in the UK, weak growth and a public debt load that is only ever going one way: up.

I do not believe that this can go on for long. Bonds are fixed rate investments with finite maturities. The price gains of 2011 have lowered the yields to maturity, in some cases markedly so, and thus diminished the chance of additional gain. Does that mean reversal is imminent? No. Maybe the notion, or better the myth, that the bonds of the United States, the United Kingdom and Germany are risk-free assets can somehow be maintained. Maybe yeileds can decline even further. Who knows? Personally, I doubt it.

In the case of the US, the fiscal situation seems firmly beyond repair. The Congressional Budget Office publishes its own projections on the long-term fiscal outlook. These are based on some overly rosy economic assumptions and still make for rather grim reading – hundreds of billions of dollars in deficits every year forever. The true path for the U.S.’s public accounts will certainly be much worse. The U.S. has now acquired a habit of running budget deficits to the tune of 10 percent of GDP year after year (more than $1.5 trillion in 2011) and there seems to be no end in sight. There is presently no deflation in the U.S. Neither does the TIPS market expect any. Yet, investors seem happy to hold U.S. government paper at what are certainly negative real yields. Investors are practically paying the U.S. government for the privilege of funding its out-of-control spending.

I have long maintained that government bonds are a bad investment because the endgame for them will either be outright default or inflation. In both cases, as a bondholder, you lose. To be precise, the outcomes are either default or default. The idea that these debt loads could be elegantly inflated away is nonsense. They are already too big for that. So either you face outright default or, if authorities try to inflate, hyperinflation and currency disaster, and then default. In either case, you will not be repaid with anything of real value.

“Let them eat bonds!”

Government bondsBut are default or inflation and then default really inevitable? What if the present scenario continues forever? This seems to be the new ‘hope’, if you like. It is not a pretty scenario in that it involves the ongoing confiscation of wealth from bondholders but it seems to be less drastic than default or hyperinflation. Could we not work off the excessive stock of debt by suppressing bond yields below (moderate) inflation rates for an extended period of time? Of course, we cannot rely on the self-sacrifice of the bondholder, although he appears rather willing of sacrifice at present. So the government will have to use all its might to force bond-investors into accepting zero or negative returns for an extended period of time. After all, the state is the territorial monopolist of coercion and compulsion. It makes the laws. And controls the banks.

As I stressed many times, in a state fiat money systems banks must ultimately cease to be private, capitalist enterprises. Many banks have already been fully or partially nationalized. The remaining private ones are under tight, and ever tighter, regulation by the state. Should it not be easy for the state to force banks to invest more in government bonds, even at low or negative real returns? Should it not be possible to redirect whatever saving and credit there is from the private to the public sector?

Such a strategy has been outlined – not advocated- by Russell Napier of CLSA. He calls it ‘repression’. It ultimately involves rather draconian market intervention in order to continuously force the diversion of capital from private use to public use at artificially low levels of compensation. At some stage it will require capital controls. But let’s face it: most of what we have experienced over the past three years in terms of government intervention would have been simply unimaginable only five years ago. We should therefore not be surprised if market intervention becomes ever more heavy-handed and is used increasingly to favour the funding of the public sector. Gillian Tett in one of her recent Financial Times articles also discusses the strategy of ‘repression’ and predicts that we will see more of it. See here.

That such a policy will be implemented, and ever more boldly, I have no doubt. In fact, I predicted it in my book. See chapter 10 of Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown, in particular pages 226 -228. I called it ‘the nationalization of money and credit’. It is a phase in the crisis but it is not an endgame. Where I disagree with the above mentioned writers is the following: Repression, to the extent that it works, will not reduce government debt, and besides, it won’t work.Book cover for Paper money Collapse

Consider the recent environment: Certain governments have been able to borrow directly from their central banks via quantitative easing and in the bond market at low or even negative real interest rates. Does that mean they have reduced the amount of outstanding debt? Are such hugely advantageous conditions used to cut back the debt load? No. The opposite is the case. Access to cheap credit, whether that credit was provided by the printing press, obedient bond investors or hyper-regulated banks, has allowed states to run larger budget deficits and accumulate more debt. Remember, we are not talking here about the workout of a debt-situation resulting from a war, a natural disaster, or some other one-off event. We are talking about the modern welfare state with its ever-growing commitments and increasingly out-of-control spending. Only cutting off the state from cheap funding will ever constrain it, not giving it access to more resources more cheaply.

And then there is this: We do not live in Paul Krugman’s parallel universe of Keynesian fiscal stimulus, where every dollar spent by the government magically translates into 2 dollars of real GDP growth. Here, on planet Earth, the constant shift of resources from private markets to the state bureaucracy weakens the economy. Shrinking the private sector and growing the public sector kills economic growth. In the perverse logic of the modern welfare state, this then requires even more state spending in the next period. As the economy continues to struggle, public sector outlays will grow while tax receipts will shrink.

‘Repression’, to the extent that it succeeds in shifting resources from the private market to the state, makes the crisis worse. It must lead to more debt, more capital misallocation and a weaker economy. We will not save our economy by trampling on the remaining bits of functioning capitalism and by confiscating more resources from the private sector. ‘Repression’ is self-defeating.

Additionally, it won’t work. Private wealth-holders will not sit on their hands forever while their hard-earned savings are being confiscated by the state. If banks become mere tools to fund the state and thus provide zero or negative real returns to shareholders and depositors, shareholders and depositors will pull their money from the banks.

But there are no alternatives for the depositors, are there? Of course, there are: Gold.

Printed money

Photographer Graeme Weatherston.

As the enemies of gold in the establishment financial press never tire of reminding us, gold pays no interest and no dividend. Because of storage and insurance costs, it is a ‘negative carry asset’. But in an environment of ‘repression’, so are government bonds and bank deposits. With zero or negative returns guaranteed on supposedly ‘safe’ government bonds and bank deposits, ever more investors, including small savers, will turn toward gold which has the additional advantage that its upside is practically unlimited – its price can double, triple or quadruple (all of which I expect) as long as paper money debasement continues, which I consider a near certainty.

Of course, a determined state will counter any evasion of controls with more controls. Maybe we will see taxes on gold investment or even restrictions on trading and owning gold. Via capital controls the country could be locked down. All of this is, of course, hugely destructive for the economy and ultimately self-defeating. I expect that we will see quite a bit of this stuff in coming years. Try and be prepared! But this will not be part of the solution. It will make matters worse. And it means that the endgame is still either voluntary default or hyperinflation and default. ‘Repression’ or ‘nationalization of money and credit’ is a policy of desperation. It is not a solution. It won’t be the endgame.

The greater fool theory

At the present juncture, any investment in government bonds requires that you adopt the ‘greater fool theory’. You must believe that there is always some greater fool out there to buy the bonds of you when you want to get out.

Earlier this week, The Wall Street Journal Europe reported about the investment views of Robert Prince, co-chief investment officer at hedge-fund giant Bridgewater. The Bridgewater guys are no slouches, having produced some excellent returns and also, notably, being long gold. Yet, I was surprised by their bullish view on bonds. Here is an excerpt:

“In the U.S., leveraged investors who can borrow money at rates near zero could find a good deal in Treasurys, Mr. Prince says.

Mr. Prince points to the example of Japanese government bonds. An investor who was leveraged three-to-one and bought Japan’s bonds at a 2.5% yield in the mid 1990s would have earned a compound average annual return of 12% a year for 15 years, he says.”

 It is no sign of health for any asset market if you have to leverage three-to-one to make a good return. Additionally, you need a greater fool: Mr. Prince may use his $4 to buy $12 of US Treasuries but that means somebody else is lending him $8 at zero rates and with no chance of any upside. Surely, that must be a fool!

You simply cannot explain current market levels with the presence in the market of the likes of Mr. Prince alone. And who is going to assure that bond prices will stay at these levels when the leveraged investors want to exit? Mr. Prince must be sure that prices will stay up here for the long run. Okay, they did so in Japan, which is remarkable but not necessarily easily repeatable. Remember that the Bank of Japan reflated much less aggressively than the Fed does at present, inflation remained at around zero in Japan while the personal savings rate was constantly strongly positive over the period in question, if declining on trend.

I agree with the assessment of one of my readers that Japan is a bug in search of a windscreen. That the bug has kept flying for so long is astonishing but gives us little comfort as to its chances of ultimate survival. That the US bug can fly unharmed for as long appears to be a rather heroic assumption.

The government bond market is still skating on thin ice – and so is the entire financial system.

In the meantime, the debasement of paper money continues.

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The nightmare after Christmas


  1. says

    On going currency debasement by the world central banks has finally had a major consequence. Today, June 5, 2011, was a pivotal day in financial history, as all forms of fiat wealth, that is currencies, stocks, commodities, and bonds, turned lower in value, while the chart of the gold ETF, GLD, shows an increased in value. Bad central bank credit policies have destabilized all fiat financial instruments, especially global financials, IXG, and world treasury bonds, BWX. Diktat is rising as a form of money, which is driving the world into regionalization for security and stability. A Global Eurasia war will be waged in Syria and Iran.

    Fears of sovereign insolvency and banking insolvency turned currencies, stocks, commodities, and bonds lower today.

    World Currencies and Emerging Market Currencies traded lower.

    The trade lower in Germany’s Deutsche Bank, and Spain’s Banco Santander, lead European Financials, lower, which turned World Financials, lower. Spain, Italy, and lead Europe, lower.

    Falling currencies turned the world’s mining stocks and the world’s mining and steel ETFs lower. Energy stocks also turned lower today. Natural resource investing became more unprofitable due to falling currency values. Debt deflation and exhaustion of central bank credit, is causing an unwinding of carry trade investment and stimulating derisking out of natural resource stocks worldwide.

    It is the world central banks’ bad credit policies that are making money bad. Bad money is destabilizing the world economically and politically. We are witnessing the beginning of the end of the AAA era. Richard Russell, publisher of Dow Theory Letters said in King World News interview, We are watching the greatest debt bubble in history about to deflate, and it won’t be a pretty sighThe investment, political and economic tectonic plates are shifting, and an authoritarian tsunami is on the way.

    Seigniorage, that is moneyness, will no longer come from banking and national governments, but rather come from the diktat of regional sovereigns. Currencies are now sinking, and global financial derisking and deleveraging is underway, with the result that the new dynamo of diktat is driving economic and political action. Political capital is replacing investment capital. The seigniorage of fiat money, is being replaced by the seigniorage of diktat.

    With the death of fiat money, regional global governance is rising to replace sovereign nation states, as nations loose their debt sovereignty. This is foretold in bible prophecy of Revelation 13:1-4 and Daniel 2:31-33. Life in the Euro zone will be characterised by collectivism, as statism rises to govern all.

    The only way to preserve wealth is to buy and take possession of gold bullion.

  2. Aodhan says

    Dear Detlev,

    Many thanks for providing these clarifying, if chilling, weekly commentaries.

    You assert above that Krugman inhabits a parallel universe. I am inclined to agree. Moreover, this parallel universe appears to be on a collision course with our real universe.

    True to form, Krugman recently accused most pundits and politicians of misunderstanding sovereign debt, and thereby overestimating the size of the problem it poses.


    He made two claims in support of this thesis:

    1) Sovereign debt is okay as long as it declines relative to an expanding tax base.

    2) Sovereign debt is okay because much of it is owed to ourselves.

    I wonder whether you would like to rebut these claims directly, for readers’ edification.

    Best wishes,


  3. Paul says

    Detlev, Thanks for another great read.

    Would I be right in thinking that due to so many bonds having being issued (many of which being paid with money borrowed from central bank printing QE) there would come a time when maturing bonds are cashed in and participants do not reinvested back in bonds because of a default risk.They would be simply held as cash. This would bring a huge amount of cash into the system and the effect of this would be highly inflationary?

    • Kevin Dawes says

      I suppose it depends whether the banks retain the cash or start lending it and I doubt they will be lending for a while now in order to meet capital/equity ratio requirements.
      This, I believe is what QE is about, to shore up the banks at the expense of the currency and pensioners/savers will take the hit while it’ll be a boon for debtors.
      However during these times of Financial Repression the relationship between banks and government becomes much more tighter and the banks will do the bidding of government to ensure its spendthrift ways. A couple of devils.

  4. David Goldstone says


    On the tax base point, Krugman says this:”all they need to do is ensure that debt grows more slowly than their tax base”. In other words, the rate of increase of the debt must be less than the rate of increase of tax revenues.

    This is true, but trivially so. The question is in what circumstances will the rate of increase of the debt be be less than the rate of increase of tax revenues? It is easy enough to model it out on a spreadsheet. Things go bad (sometimes very quickly) if:

    1. The rate of increase of tax revenues is less than the rate of increase in spending.

    This is true irrespective of the interest rate on the debt (unless it is zero which is impossible) and irespective of the size of the initial debt. In all cases, if tax revenues rise more slowly than spending, the State will eventually become insolvent (I define insolvency, generously, as the point at which interest payments alone exceed tax revenues).

    2. Even if the rate of increase of tax revenues is greater than the rate of increase in spending, the State will still become insolvent if the interest rate is high enough.

    In fact if the interest rate is sufficiently high then the State will quickly become insolvent even if it has a balanced budget in year 1 and even if the initial debt is small.

    If you take the present numbers – say debt 15m, spending 3.7m, tax revenue 2.3m – then even if the revenues grow at 3% and spending was frozen indefinitely (both completely unrealistic assumptions) the Government would quickly (hardly more than a decade) become insolvent if the interest rates were to rise to 6%.

    Even with vaguely plausible assumptions (say tax and spending both rising at 2% p.a.), the government would be completely insolvent within a few years if the interest rates rose to even 4%.

    There are other permutations but they are pretty much all bad. Basically the only thing that is keeping the Governent alive is artificially low interest rates. But they bring their own problems …..

    The “we owe it to ourselves” claim is rebutted here: http://lewrockwell.com/anderson/anderson330.html

    • Aodhan says

      Dear David,

      Thanks for pre-empting Detlev. I was just interested in his personal take.

      I fully agree with you.

      Krugman first claim, while true, is vastly presumptuous. What ensures that the tax base will increase more quickly than the debt burden accumulates, particularly under hamstring economic conditions, and with interest rate rises looming (as you point out)? Sounds like an risky gamble to me.

      Krugman’s second claim just strikes me as logically incoherent (and I have heard others, like Skidelsky, put it forward with equal condescension). X cannot owe X anything, whether X is an individual or a collective. For owing to occur, there must be a non-identical X and Y, one of whom owes the other. If the implied idea is that domestic lenders will be more forgiving than foreign ones, well, that may be true to some extent; but the idea that domestic lenders can tolerate wholesale default by domestic borrowers without widescale economic disruption seems ludicrous. Maybe the idea is that “our” children will pick up the eventual inflationary consequences for “our” spending. What a thoughtful bequest!

      • says

        David and Aodhan, I saw the Krugman article. I even thought about writing a blog about it, or at least work his article somehow into my latest blog. In the end I decided against it. I think everybody is giving Krugman too much attention. I don’t care if the guy got a Nobel, this whole thing about “we owe it to ourselves” is such complete rubbish, it is truly embarrassing. Of course, both of you are absolutely right in your critique. Any form of debt establishes a contractual relationship between a borrower and a lender. And these are certainly two different entities. That is why one person will book the government bond as an asset on his balance sheet, while another person (or entity) will book the same bond as a liability on his (its) balance sheet. When interest or principal come due, somebody receives money and somebody pays money. Banks, pension funds and insurance companies hold billions of these securities as assets. Should we tell them to pay themselves some interest and principal when these contractual payments fall due? Do they agree with Krugman that these assets are also their liabilities at the same time? What happens to the people who save and put their savings into government bonds? Do they have to pay themselves in the end? Economics is all about the co-operation on markets between individuals or groups of individuals. To aggregate these relationships up on some national level where they then appear to cancel one another out and thus pretend that these relationships do not really exist in the first place, is absurd. It means completely ignoring the contractual relationships that are in fact the very drivers of economic activity. This is aggregation gone mad.

        The government has the power to confiscate private income and private property to pay for its debt. Besides money-printing this is the only way in which the government can ever meet its debt obligations: through confiscation. The state is not engaged in production. The state only consumes and redistributes. Now if you are a shareholder in a private company and the owner of a government bond at the same time, you could argue that to some degree you are paying for your income from the government bond yourself: the government taxes the private company, and thus takes from you as its shareholder to pay its obligations from the bond, and thus gives to you as the owner of that bond. That does not mean that you “owe it to yourself” but simply that the government forces you to pay for your own income from government bonds. The problem is that you treat both of these security holdings as “assets” that will both pay you an income in the future, when in fact one asset is simply a claim on the income from the other asset. Rather than showing that government debt is harmless, as Krugman is eager to do, this example illustrates the parasitic nature of government debt. If you buy a government bond you buy a ticket that allows you participation in the confiscation of market income and private property – including your own income and private property! It is also clear that none of this means that there are no limits to the issuance of government debt. The more government debt is in existence the more claims exist on the remaining private and productive capital. The price of your shares in the private company should be discounted ever more heavily with every issuance of government debt – although, I am sure that with their warped economic logic, Krugman and Skidelsky will tell you that your shareholding becomes ever more valuable because the issuance of government debt will increase aggregate demand! Fact is this: at some stage the claims on income from productive activity in the economy will get too big. The parasite is then killing the host. And when the bond market realizes that only extremely high, destructive and self-defeating levels of taxation will allow the state to ever repay its debt, the market may conclude that default has become a more realistic option or even a necessity.

        What concerns me very much is this: most commentators have lost sight of the fact that rising government spending and rising government debt have massive implications for the allocation of resources and therefore the ability of the economy to create wealth. Large deficits and substantial public debt loads are indications that limited resources have constantly been diverted and are still being diverted from private markets to bureaucratic employment by the state, that savings have been re-directed back into consumption, and that people hold assets that are not backed by productive capital but that are simply claims on the returns from other assets.

        Besides, Krugman strikes me as paranoid. What is he worried about? The US state does as he preaches and is spending like a drunken sailor, and has been doing so for years! His article gives the impression as if undue concern over deficits prevented the US state from conducting the helpful Keynesian deficit spending he prescribes. But Krugman is simply worried about rhetoric here, he agonizes about debates. Having become a Democratic party hack more than an economist he constantly fears the “conservative movement” which apparently keeps him awake at night. In fact, actual policy on the ground is nothing if not Krugmanesque to the extreme! The US state has been running the largest deficits in its history for years now. 10% of GDP, year in and year out! In fact, the $1.5 trillion deficit is entirely the result of the explosion in spending. So what is he complaining about? Keynes would be happy about this policy! Have we reached full employment yet? — Ah, but wait a minute. Krugman starts his essay by pointing to the dreadful state of the economy and the labor market in particular. He tells Washington to stop listening to economists who worry about debt when in fact interest rates have not risen yet in response to the growth in deficits and debt levels. But should Washington not stop listening to Krugman because the economy has not improved in response to the very medicine that he has been prescribing? Professor Krugman, what does it take for Keynesian policy to finally work? Does Keynes’ policy not work at 10 percent deficits but only at 20 percent? What about 30%?

        Don’t read Krugman. It is a waste of time.

        • Adriano says

          Hi Detlev,

          it seems to me that while money hyperinflation is yet to come, hyperinflation of the Nobel Prize for Economics has been puffing ahead full steam for a long time!

          “To aggregate these relationships up on some national level where they then appear to cancel one another out and thus pretend that these relationships do not really exist in the first place, is absurd”

          Is this crystal clear statement of yours so difficult to understand to those highly-minded Nobel Prize???

          “But should Washington not stop listening …? Professor Krugman, what does it take for Keynesian policy to finally work? Does Keynes’ policy not work at 10 percent deficits but only at 20 percent? What about 30%?”

          If Politicians do not what to consider the Austrian economists, they could at least pay attention to what Milton Friedman said! During an interview he made arguments similar to yours about public spending, answering in this way: “if, as you say, 40% GDP of publig spending was any good, increasing it to 50 or 70 or 90% would be even better!”

          I hope you will reconsider writing a blog about Krugman maybe also including some considerations on the new “breakthrough” economic discovery of the other famous Nober Prize J. Stiglitz:

          (Note: Vanity Fair – The new economic bible of out time)

          Technology is to blame for economic crisis(??!!??)
          What a NONSENSE made gospel!

          As usual, there are always “smart” guys willing to carry the message along:


          Manufacturing is over, that was the 20th century and this is the 21 st. Simply forget about the nostalgia for tens of millions of people making things that can be dropped on feet. It’s not coming back, whatever we do, we need to find new things for people to do instead.
          That’s the real lesson of the Stiglitz story. Manufacturing as as source of mass employment is dead.”

          That’s simply INSANE: “we need to find new things for people to do instead”!!! Of course in this case the equation will turn out to be: “we”=”the government”
          I would have many comments about but I leave you with the fun.

          Anyway, it seems that someone in the mainstream media is finally getting the message and starting to call things with their proper names (“Ponzi Planet: The Danger Debt Poses to the Western World”)


          Finally a question: what do you think about Ron Paul?

          • says

            I am not very optimistic when it comes to politics as a problem-solving device. Government is the reason we are in this mess although the public is happier blaming greedy bankers, speculators or “the market”. We have a democracy today, and we are constantly told that millions died in wars and revolutions so that we could enjoy democracy. So people believe that government and politics and the state are now all noble institutions. Democracy is the new religion and the democratic state its new deity. At the same time, people mistrust the market and the economy, and regardless what a mess the government makes of things, the solution is always thought to be in more, better or improved politics. I couldn’t disagree with these sentiments more but because things are what they are, I think politics will continue to make a mess of it and the public will continue to give politicians the license to do so.

            This introduction is just to illustrate my disillusioned and cynical take on modern politics. This is why I do not want to get involved in the political process, and why I have little hope that it will change anything. I am not following the US presidential election closely. From what I know about Ron Paul, he wants to cut government spending drastically, end all foreign wars and bring back the troops, he wants to abolish the Fed and return the country to a gold standard, to a small state and to balance budgets. All these goals sound extremely sensible to me, and as Ron Paul is the only one advocating them, he appears to be the only one with an agenda that a rational, economically literate American can vote for. Alas, he doesn’t have a snowball’s chance in hell of becoming President. Funny enough, I think most of what I listed above as what is my understanding of his agenda will ultimately be implemented – but not because the American public will vote for it in 2012 but because after a massive economic crisis in the not too distant future – a sovereign debt and paper money crisis – this will be implemented out of necessity.

        • John Campbell says

          Thank you Detlev for continuing to educate me. I read less and less of the conventional “wisdom” (ignorance) – amply demonstrated by Krugman and many others. It is a complete waste of time – I agree. Since I plunged into all this after reading your book, I am concentrating on becoming educated in the Austrian school. I cannot thank you enough.

          I would make one point about Krugman and the legion of his colleagues and fellow travelers. He calls himself an economist and he preaches economics, but he begins with a political assumption. He believes that the state, or perhaps society, is the ultimate economic and political unit of humanity. So when he casually dismisses the fact that we owe debt to ourselves, he is correct, in a way, based on his assumptions. Individuals within society will suffer massively when the default comes, but he believes the state will live on and that is ultimately Krugman’s only concern. We are all just cogs in the great machine of the state that must carry on regardless of the damage to the machine and its parts. Survival of the state is the imperative and Krugman’s economic principles flow from that.

          And of course the ruling classes must be preserved as well, since they are indispensable. You can lose a kidney and survive, but not your brain. Krugman certainly believes he is part of that indispensable part of society that must survive, while most of us are expendable.

          Krugman’s economic theories and ideas seem not quite so crazy when one remembers that he does not care about the individual economic actors – individual people. Now of course Krugman’s ideas will run into the brick wall of reality sooner or later and the state may not survive – at least I hope not. His political notions do not fit the reality of man’s nature so ultimately his ideas will fail, but his economic failures will be based ultimately on his moral and political failures as I see it. His paranoia may be well placed – I suspect he is aware that profound changes are on the way.

          In the meantime Detlev, please keep up your fine work. I look forward to your next book. I apologize for my impatience!

  5. Vance says

    If things get real bad, governments/media would not tell you plainly, you will just see the new taxes (Carbon Tax etc) appear, strange price hikes which go unremarked and the millions more new immigrants the West allows in enabling a bigger fiat pool of printed depreciating debt money. This immigration step also increases the velocity of money attracting VAT each purchase with more people needing goods and services.
    Sometimes you don’t see rats, only the fiat droppings.

    • says

      I don’t quite see the connection to immigration. In my view immigration is only a problem because of the welfare state. We live now in societies in which everybody who lives within a certain territory has claims against the state, and thus claims on the incomes and property of others in that same territory. In a truly free society with a free market, private property, hard money and no welfare state (no state at all or a minimal state), immigration would not be the problem it is today. But all of this is tangential to the fiat money debate. I don’t see that immigration has a systematic effect on the velocity of money. I cannot see why it would weaken or strengthen the various phenomena that relate to our fiat money economy.

      • Vance says

        Detlev: Immigration is a forced injection of economic activity into an ageing Western world. Western states seek to poach (preferably) skilled people trained at someone else’s expense to keep going the phenomenon of endless credit inflation. Or people who’s children will be labourers, consumers or other participants in markets. This internal colonization keeps wages low and house prices (and other essentials high). Here in Australia it is particularly blatant. VAT/MWS/GST is a key plank in creaming the sweating masses, as well tax at source.
        If you have 10 people needing $10k a year, you will need , say, another $10k the next year to pay the interest on the fiat, as well as to pay for the inflation. Hence the need to force inject ‘bonded’ people. The year after that you will need another 12k and on it goes as it compounds. You need an ever increasing supply of effectively bonded people to pay for the ever increasing mountain of debt.
        Immigration boomed in the 70′s on as the world phased out Bretton Woods and went into the Ponzi scheme of endless credit expansion and concomitant inflation.

        • Amaliskay says


          I am child of immigrants to Europe, and I basically agree with your idea. We are accepted into Europe by the political elites not out of any sympathy with us or love, they look as much down upon us as they do their native citizens. But rather as tax cows and diversions for the citizens so they can keep their powerplay ongoing. This might sound extremely cynical, but this is simply my suspicion.

          They do not have the same classic liberal outlook that Detlev is displaying above.

          But luckily as Detlev has shown in his book and what can be seen from current policy is that the expansion in money and credit is almost becoming(or rather has been) exponential. As in all exponential growth the endgame is the quickest and so it will be for the crack-boom and hyperinflation of our fiat-currencies.
          Hopefully at that point people will not listen to the political leaders….hopefully. Ron Paul is bright spot though, maybe US will be the safest country in this whole debacle.

  6. Jim Comeau says

    Hi, does anyone know what Canada is doing in terms of QE. I see lots of stuff on the US, UK and the Euro. I am a worried Canadian.

  7. David B. Schuster says

    Thank you for the insightful column (as well as the Adam Smith Institute video awhile ago). As I attempt to understand, let me present the Keynesian argument. Banks loan out ten times as much as they have on deposit. This allows for repayment of the principal only, but the money does not exist to pay the interest. So banks must create more money by making new loans. If no loans are made, we get defaults and deflation. The stimulus plan is for government to create the money to repay the loans and get the gears of the economy moving again. In a liquidity trap, the extra money gets stuffed into pockets and vaults, uninvested, so you can print money all day without inflation. Unfortunately, the economy can stay depressed for a very long time, until you get some national emergency that justifies reduced consumption and massive government spending.

    • says

      David, I am not quite sure how to read your comment. Are you being sarcastic or is this a serious presentation of the Keynesian view? I think most Keynesians would not agree with your summary, although you certainly reflect their faith in the power of government stimulus correctly. Listen, Keynesian economics is fundamentally flawed, and its disproportional influence on public debate and policy-setting in the 20th century and up to today (disproportionate because not justified by its lasting contribution to economic science, which is marginal at best) is down to the specific confluence of sociological, historical and political factors of the time, not least of them that Keynesianism provides a “scientific” excuse for governments to do what they always like to do: take control, spend more, borrow more and print more money. Future historians will marvel at our obsession with Keynesianism, which is already fading in my view. As to economics as science (rather than as an excuse for political activism), Mises was correct to pay little attention to Keynesianism in his magnum opus, Human Action. My interest in Keynesianism is mainly confined to the following: As one of the dominant strands of modern macroeconomics in the second half of the twentieth century, it shaped popular perceptions on how the economy works, how crises come about and what we can do about recessions. All these perceptions are wrong. As recently as two generations ago, most economists would have labelled these views rightly as those of cranks. But now these ideas define the public debate (they still do but probably less and less so), and together with the popularized views of Monetarists (who are Keynesians in methodology!) these views constitute an intellectual roadblock for a proper understanding of the dangers of elastic money, and therefore an understanding of the true origins of our present predicaments. That is my interest in Keynesianism, and that’s all. (Please see chapter 9 of my book!) I did not set out to refute Keynesianism in particular, simply because there is no need for it. Intellectually, if not politically, Keynesianism is already refuted. Other authors have already done it. If you want to read a proper destruction of the Keynesian argument, read Henry Hazlitt’s excellent book The Failure of the ‘New Economics’: An Analysis of the Keynesian Fallacies, which was first published in 1959 (!), and George Reisman’s remarkable “Capitalism” (1996)!

      There is one point in your comment that is similar to a point that Vance makes in his comment on immigration today, and that has appeared in a number of comments over recent weeks. The point is something like this: banks create money as part of their loan business but they just create enough money for the principal to be repaid. Where does the money for the interest come from? – Behind this is a grave misconception about the monetary economy. What you describe (and others, as I said, have made a similar point in their comments) would only be a problem if all money in the economy came into existence in one act of loan creation, and all that money would disappear again when the loan gets repaid. This is obviously not how it works. Banks can only create money as part of their lending business because money already circulates in the economy. The banks ADD to the money supply, and what they add does not disappear or get destroyed whenever loans get repaid. Why should the banks do that? They will lend the money out again, and if they can, they will lend out more. They will only shrink the money supply if they have to shrink their balance sheet, but even then not all money disappears. So if we accept that banks can expand the supply of money and, if they are in trouble, also occasionally contract the supply of money but that they never bring all money into existence and then destroy all money again, it is clear that no shortage of money exists to pay interest. Remember that every unit of money can facilitate numerous transactions, you do not need new money for a new transaction. I pay money to my gardener who then uses the same money to pay somebody to clean his van, who in turn pays the same money to the butcher to buy meat, and so forth and so forth. As I explained in detail in my book, once a substance (let’s say gold) has become money, the available quantity of this substance is sufficient to facilitate ANY number of transactions, including additional loan transactions. Remember also that you repay a loan not with newly printed money but with your real income. Let’s assume you have used a loan to start a business. You repay the loan out of your profit, which is the income that you generate minus the expenses you incurred from running your business. In a way, some of the extra goods and services that the loan helped bring into existence by allowing the start of a successful business (and that have ended in your possession as profit!) are being sent back to the banker (and, in a proper hard currency economy, the saver who is the real originator of the loan in the first place) as compensation. In a money economy, units of the monetary substance will be used to facilitate these transactions but you could consider payment to occur in form of real goods. Some of the circulating money will go through the hands of the entrepreneur and then through the hands of the banker and those who fund him, etc, etc,, just as in the example above. The idea of a shortage of money to pay interest is nonsense. But, and this is the real point, it is true that banks can create money out of thin (within limits if they are private banks, without limit if they are central banks) but non-banks always have to earn the interest they pay in the market place. Therefore, the money-producers have a substantial advantage over the non-banks. To speak of a shortage of money to pay interest is, however, incorrect.

      • Vance says

        Hi..you suggest some views of money creation are flawed as it would only be so if ‘all money came into existence in one big loan’. May I be so bold as to suggest we are talking about two different things.? We are talking about 1. elastic ‘money’ on the public side of the ledger (as loans made by banks and central banks), and 2. non-elastic equity ‘money’ on the private side of the ledger held by humans that can’t print their money supply, as banks can print theirs. Banks lend ‘money’, but are repaid their loans in equity units of real value created by labour, creativity and risk that was expended to produce goods and services. Moreover these goods and services as you rightly imply have a transcending ‘ideal’ value ie a window that costs $300 but can be used to keep out the weather for a century or more, which is hard to put a money value on. Banks and govts want equity, not money.
        My immigration point was that in fact the system needs to expand to pay the elastic debt and to provide the needed services/goods. The system needs new skivvies to provide depth to the pool of money laundering if you will: elastic loans out- equity money scooped back to the market makers.
        Govts don’t care about the plight of refugees,human rights of migrants, social impact of millions of strangers injected into a society in one generation etc- its all about converting ‘fiat money into equity and hard assets’ using uncomprehending politicians/bureaucrats and innocent workers as tools.
        You rightly say that we don’t pay our loans in newly printed money- but we ourselves may have been paid with newly printed stimulus money if we are on a govt or corporate teat, especially with Keynesian stimulus payments everywhere. So the fiat goes through our pocket, becomes worth something as equity because we can’t stimulus ourselves, and we give it back to bank and govt in loan repayments and tax. Am I making sense? If not, thanks for your patience all. Love all your comments.
        Thanks mate.

        • David B. Schuster says

          Detlev, if you’ll let me take a stab at Vance’s post, I would say that if you owe taxes or interest on a debt, then you are an incoming producing asset. As such, you are property and your well-being is not a concern, only your ability to pay. And payments must be made with real assets, so unless you have access to a printing press or gold under the bed, then you must pay with the products of your labor. So banks and government create money to purchase real assets. From what I understand, this is the complaint that other countries make about America and the dollar’s use in international trade. Other countries are forced to trade real assets for oil and other imports.

          To your point, this seems like a racket. Money is created and through its acceptance in the marketplace, it is converted into a real assets. Immigration achieves this conversion through the use of labor. However, I usually see the immigration argument used in reference to transfer payments from the government. In Japan and America, more people are retiring from the workforce than new people are entering it. Naturally, if people are collecting benefits faster than money is being paid into the system, then the racket is over. Ponzi schemes are sustainable as long as more people are paying in than there are collecting.

          And lastly, there is the issue of default. If somebody takes out a loan and they cannot make a payment, then they default. End of story. Although you could take out a new loan to make the payments. But due to compound interest, each new loan must be a little bit bigger than the previous one. So your debt grows exponentially, until it is defaulted upon. The other alternative is to print money, until it loses any value and you default. I saw a quote by Voltaire that said all paper currency eventually returns to its intrinsic value.

          So all debts that cannot be repaid will be defaulted on. It is just a matter of time. The only intelligent response is to have real assets, such as gold. But if I may offer a counter narrative, then banks and governments are not half as stupid as they seem. What if they are planning to run the dollar into ground? Rather than a return to metal, we could swing to the other extreme, to a strictly credit system of digital money. Dollars would be revalued in the new currency and the borrowing/inflation process can begin again.

  8. David B. Schuster says

    Thank you for taking the time to contribute to my education. It was a intended to be a serious comment, my interpretation of the Krugman argument.

  9. Rob says

    Detlev – I ‘enjoy’ reading your articles greatly. Apart from gold are there other assets one could buy now that might survive or prosper in the ‘coming fiat money collapse’?

    Given your comments on ‘repression’ presumably governments would confiscate or destroy any other remaining private assets of value, so we are back to hiding gold/silver coins under the floor boards?

    • says

      Rob, let’s go down the list of assets: gold and silver are on top. I think they are the essential self-defense assets in this environment. As the fiat money economy unravels, more and more people will turn to the eternal form of money to protect their wealth, and that, for me, means gold in particular. Next on the list are other “real assets”: land, arable land, forestry, real estate, and productive capital, i.e. equity. I am agnostic when it comes to those. I can see why certain forms of real estate could be attractive. The problem is this: what location, and that includes what political jurisdiction, do you want your real estate to be in? I am no expert here but I am concerned about the dreadful state of public finances. For the taxman, real estate is low-hanging fruit. Investing in real estate will be similar to investing in equity. Success will not be about owning the asset class, it will all be about stock-picking, about finding the right pieces of equity or real estate in the right locations, and I am no expert in this area. As an aside, equity markets might not even go down a lot in nominal terms, in my view. They should do better than bank deposits and bonds but they should lag behind precious metals and not compensate you for monetary debasement. Next on the list is fixed income. The bond market is the biggest market in the world, the most overvalued, and it is the asset class that is going suffer most from the fiat money meltdown. Government bonds are a short – although timing this trade is a challenge.
      ‘Repression’ is coming and there are no sure ways of escaping it. All you can do is diversify internationally and try to always stay a step ahead of the confiscators and redistributors without breaking the law. Supposedly, when Roosevelt confiscated all privately held gold in 1933, the feds only got their hands on about 20 or 30 percent of the gold. (I have not yet been able to confirm this but I was told it is in Friedman/Schwartz’s Monetary History of the United States. I will check in due course.) Why? I guess a lot of people engage in “midnight gardening”. Also, if you held your gold abroad, it wasn’t confiscated.

      • Rob says

        Thanks Detlev. You can buy physical gold ETFs based in Switzerland where one would hope they have more to lose from harassing foreign investors than from leaving assets alone. Some gold coin on hand might not hurt either. Gold Sovereigns are free from CGT as they are legal tender.

        Presumably inflation linked bonds in the UK and US would be a target for ‘repression’ and might not be honoured, but long dated ones might do well at the beginning phase of the breakdown.

        On the equity side I guess products people will still have to buy such as consumer staples, healthcare and pharma and some REITS could benefit although not secondary commercial property ones. Interestingly a highly geared business with fixed rates but with pricing power would leave its debts behind. Overall though it will be difficult to run a business in such an environment, and very difficult to make enough money to outweigh the effects of the monetary debasement.

        Keep up the good work Detlev. I enjoyed hearing your spell on Start the Week and you seemed to get some support from Phillip Coggan; so you may not be the lone voice in the wildnerness for too much longer!

  10. Rafael says


    consuming the well-written contents of your book provided great pleasure and insight into the corners of our current economic and banking systems. Thank you for the conceptual-based and logical explanations you laboured on to demonstrate your arguments. It is difficult not to agree with the foundations of what you lay bare. And through mainly luck (and some foresight) I have benefited from these same concerns by holding gold and inflation indexed gov’t bonds in the past years.

    However, I also wish to present evidence of a possible alternative to the reckless and self-destructive government printing press. Canada experienced a very challenging fiscal period in the early 1990′s, coupled with an effort by Quebec politicians to secede, US & world growth falling sharply, interest rates at double digits, a housing bubble, very high unemployment and strained corporate balance sheets. This has been nicely revisited in a piece by Scotiabank economists on December 9, 2011: Germany’s Case Is Buttressed By Canada’s Experience.

    Canada did not resort to monetary expansion, but the government of this ‘banana republic’ (I remember this well when some of our American neighbours labelled us this) pulled up its socks and slashed spending aggressively to balance it books once more. The country now finds itself in an enviable position amongst it’s G7 friends (though there are without a doubt great pressures and there still is significant uncertainty).

    Yes, the world’s present reserve currency superpower still enjoy’s just that – a liquid and reserve advantage over others playing the monetary game. But it is true that good fortune does run out. But it may also be true (or possible anyway) that the satellite monetary regimes (Europe, Canada, Asian etc) are able to survive and continue through hard action (like Canada performed, and some Scandinavian nations too I believe) while the US slowly grapples with it’s mountainous problems? Though some of America’s processes and ‘solutions’ truly make me shake, I have learned from experience (and history) that despite their shortcomings and self-interests you can’t count them out.

    Anyway, I largely accept your sobering arguments and wish we were not subject to even 2% inflation (it really is insidious and destructive to the individual even at this ‘moderate’ level), but I feel sometimes theory and true stories don’t always transmit well into reality. I hope that’s the case for the current situation, though I readily admit there’s plenty to make one nervous.

    Thanks for a great book & forum and spreading your message, truly R

  11. Kagotho Nderitu says

    I have read Detlev Sclichter and the subsequent comments but it looks like Detlev and most commentators are anti-Keynes. From Detlev, who carefully avoids mentioning the role of private banking in the current global financial crisis, one reads that it was OK for public to carry the burden of private losses but the other way round is draconian and unacceptable. Government bonds are a bad idea anyway and should be discouraged. They are an easy target for those holding money already and they have been know to be manipulated. A new economic model should be developed which encourages strict monetary polices and increase in taxes to meet public spending. Detlev economics to me sounds like Reaganomics which caused the ship to hit the reef in the first place. But the captains are evading the blame.

    • Deft says

      Wow! If that is how you have interpreted things I suggest you read again until you really understand what is being suggested…

    • Adriano says

      Dear Kagotho,

      “From Detlev, …, one reads that it was OK for …”

      The point is that in order to be able to say “ONE READS”… you should READ, first!

      Apart from that… yes, I am anti-Keynes and, as such, I do not disagree with all you say! Why?
      Because, according to what you say, you are anti-Keynes as well!

      “A new economic model should be developed which encourages strict monetary polices and increase in taxes to meet public spending.”

      I would remind you that the Keynesian taught is for the goverment to put sistematically in place deficit spending as the only effective means to keep the economy going. So, for Keynes and the like, government bonds are a good idea and should be encouraged.
      Moreover, for the Keynesian school inflation is also a good thing!

      That is to say that your “new economic model” is simply anti-Keynes.


  12. Rob says

    I completely agree with your premise and prediction and applaud you for not getting backed into the “when” question – other than consistently saying “…2-5 years.” My question is do you see this happening very quickly as in 2-3 trading days or is this spike in interest rates and a “run on American paper” likely to happen over the course of 4-6 years?

    • says

      Rob, unfortunately it is again difficult to make any precise predictions. Logical analysis can help us identify the fault lines and cracks in the system, and it can tell us what the tipping points could be. But how and when this thing will unravel is pure guesswork. I believe that this will not be over in a number of trading days. When people start selling government bonds, the central banks will have to buy even more aggressively. At that point the dynamic changes. We will see a tug-of-war between the market and the authorities, which will desperately try to postpone the inevitable. We will also see other interventions, such as capital controls. All of this will take longer than a few trading days. At least, that is my guess. How long can this go on? Difficult to say. A few quarters to a year, maybe.

  13. daniloux libertarian says

    Yesterday, interest rates upon italian 1 year bonds dropped by 50%. It really doesn’t seem they’re stopping to buy government bonds :-) On the contrary it might be that the recent mega loan of the Ecb to the banking industry was largely directed to fund government shopping spree. The spyral of debt-inflation can continue because the figures on inflation are extremely manipulated and then the Ecb can feel “authorized” to “act”. This democracy is a scam, it is self regulated on gigantic lies. Go ahead Detlev!

    • says

      This has been going on for a while. Central banks around the world are sitting on trillions of currency reserves that are nothing but the paper money that the other central banks are printing. Understandably, they are getting a bit nervous about it. In public debate, you often here the view expressed that China must be wealthy because it is holding all these US Treasuries. This is nonsense. These Treasuries are all but worthless (in the meantime, the Americans are enjoying the Chinese goods they bought with them). China cannot get out of that position without causing havoc in financial markets and they cannot swap them for any real assets in the US. (China buying Disneyland, or large swaths of US farmland? – forget about it!). The debt will never be repaid because the US is going broke. Interest will be paid by issuing new debt.
      Central banks should be buying gold – and this will continue. I don’t think there is any deeper meaning behind it. They are not preparing a return to a gold standard, or anything like this. More importantly, we as private individuals have to protect ourselves with gold!

  14. Julian says

    Hi Detlev,

    A big concern for bond investors is the risk that bond yields might rise resulting in significant losses on bond portfolios. Yields are at historic lows and show no sign of rising anytime soon. However, it is not clear to me why, when the Feb buys bonds, for example, yields should drop. Obviously when the Fed purchases bonds upward pressure is put on bond prices which reduces yields. However, since those Treasuries are purchased by the Fed with printed money, would not I as an investor demand a higher yield to compensate for the debasement of the bond’s cash flows? Do not yields reflect societal time preference, risk, and inflation? And if there has been monetary inflation, should not the yields on net be rising? I would have expected that yields should have risen given all the monetary inflation, but they remain stubbornly low. Interested in your thoughts.

    • says

      Julian, you are right. QE is ultimately self-defeating, like all attempts at price-fixing and all other government interventions. Those who believe in this nonsense think that the government has finally found a way to square the circle, to create a new reality. QE has two immediate effects: it increases the supply of money and it makes it easier (cheaper) for the government to borrow. Over time, the larger supply of money will lead to a drop in money’s purchasing power. Also, the outstanding (public) debt load increases – just look at the US. Both these effects are detrimental to bond holders. They will – sooner or later- ask for compensation in form of higher yields, which is exactly what the central bank doesn’t want. As I said, it is self-defeating. The problem is that the bond market is – at the moment – still ignoring or, at any rate, heavily discounting these effects. A lot of the newly created money is sitting on accounts at the central bank in the form of excess reserves of the sick banking sector. Banks are too scared to lend to the private sector and the private sector too scared (too clever?) to borrow. But the excess reserves (provided for free and without limits!) keep all banks alive – another market distortion and, to a large degree, the true reason why QE is being conducted. But at any rate the money is presently not feeding into traditional measures of inflation (consumer prices) that quickly. But it will over time. Inflation has already risen marginally everywhere last year – and that will continue. This inflationary risk is being ignored by the bond market. As to the solvency-question, my view is – from my own experience of almost 2 decades in the bond business – that the bonds of certain governments have for so long been deemed ‘safe assets’ (a nonsensical concept in capitalism!) that bond investors seem happy to ignore the dramatic and incorrigible deterioration in public finances in countries like the US or Japan. In a way, bond investors are saying this: “Inflation is not a problem right now so I ignore it. These fiscal problems can be fixed. Maybe they will be addressed after the next election. And also: what else should I do with the money? I have no choice. We are in a financial crisis. I cannot buy more stocks and corporate bonds. They are risky assets. I could look really silly. Government bonds are a safe asset. I can’t get fired for putting my clients’ money into safe US Treasuries in a middle of a crisis, can I?” — This may sound a bit facetious but I truly think that is what is going on.
      But it won’t last. The central banks have created a massive powder keg, and every time they do more QE, they are playing with matches! Your analysis is correct. When the market catches up to it, things will unravel quickly!


  1. [...] … Let them eat diktat, as in capital controls. Detlev Schlichter in Paper Money Collapse writes When They Stop Buying Bonds, The Game Is Over I have long maintained that government bonds are a bad investment because the endgame for them will [...]

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