Dear readers, first of all, apologies seem in order. An unusual gap between blog posts has appeared on the Schlichter Files this summer. The reason is that I was travelling with my family in East Africa through most of August, enjoying the spectacular landscapes and the fascinating wildlife there, and meeting some very interesting people. Although, admittedly, I travelled in considerable comfort, and East Africa offers today reasonably good internet connections, often even in fairly remote areas, I decided not to read any newspapers, websites or even my emails for a few weeks, and instead tried to take my mind off the depressing subject of monetary meltdown and the destruction of capitalism and the free society at the hands of politicians and central bankers. So here I am, back in London after almost a month in the relative wilderness, slowly and reluctantly catching up with events in the strange world of 21st century finance. My first impression is that I have not missed much in terms of the unfolding crisis. None of the dynamics have changed. If anything, I feel my dire predictions and gloomy outlook again confirmed by recent events.
Where we are
Last month we entered the sixth year of this crisis, although parts of the media seem determined to continue calling it a ‘recovery’. Wishful thinking. We have been in continuous crisis for half a decade. Doses of Valium and Prozac – called QE among central bankers – have calmed nerves occasionally and given the false impression of healing.
QE, or ‘quantitative easing’, is, of course, the creation of massive new quantities of monetary units and their targeted injection into financial markets for the purpose of manipulating asset prices and interest rates, and of flooding the banks with extra free reserves. QE is a dangerous drug. It is a hallucinogen. It can make you feel better for a while but it won’t cure the disease. In fact, it makes you sick. The global economy suffers from grave distortions that are the result of years and decades of artificially cheapened credit: Overstretched banks, too much debt, inflated asset prices, misallocated capital. Cheapening credit further – and manipulating asset prices further – is, however, the MO of QE. QE encourages additional borrowing and further balance sheet expansion.
QE – and zero interest rates – is the policy equivalent of crack cocaine. It makes addictive. There is no end to it.
I was reminded of this when I opened the newspapers last Thursday for the first time in almost a month, and learned that the Fed might be on the cusp of another round of QE.
“Fed Minutes Signal Action Likely”, headlined the Wall Street Journal, “Fed shows a strong consensus for action”, the Financial Times.
Whenever the policy elite is promising more action you should get very concerned.
QE – to the bitter end
When compared to their peers among the global oligopoly of state money printers, the Fed bureaucracy has had a rather quiet spell over the past 12 months. The Fed only conducted some balance-sheet neutral bond price manipulations (‘Operation Twist’) but refrained from any money-printing worth mentioning. Since the crisis started in July of 2007, when the bottom fell out from under the US subprime market, the Fed has, of course, created a cool $1,900 billion in new money in the form of bank reserves. Its balance sheet has more than tripled. But most of this money was created during QE1 – after the collapse of Lehman in 2008, when the Fed bailed out the US banking system by taking over more than $1,000 billion of its mortgage exposure – and then during QE2 – when the Fed created another $600 billion to manipulate the prices of US Treasury securities. But in year 5 of the crisis – July 2011 to July 2012 – the monetary base has remained unchanged, for the first time in any one-year spell since July 2007.
Such impassivity is not becoming for the most powerful central bank in the world, in particular when the Bank of England is already on QE3, and the ECB has just expanded its balance sheet by more than 50 percent. (Incidentally, the ECB, the pantomime villain among international QE-enthusiasts because of its supposedly Bundesbank-inspired hard-money line, created more money, at least exchange-rate adjusted, since 2007 than the Fed: EUR1,800 billion. As I keep saying, when I look at the world’s major central banks, I see sameness, not divergence.)
Bureaucrats can, of course, not sit still for long. People might get the idea that they are useless and that we don’t need them, or, heaven forbid, that their work is even positively harmful. The bureaucrat cannot allow these concerns to emerge. Through ‘action’ he has to remind the public of his vital importance to society. By contrast, private companies are ventures that are ultimately controlled by consumer demand, and that are therefore usually limited in time. They emerge, grow and prosper, decline and die when consumer tastes change or better competitors come onto the scene. Not so the monopolistic state bureaucracy. It is built for eternity. Regardless of how disruptive, harmful and distortive the central banks’ ongoing money injections and cheap credit policies have been over the years and decades, and how culpable the Fed (among others) has been in creating and maintaining vast imbalances, the central bank bureaucrat has to go on with his work. He can’t question his mission without questioning his own existence.
Part of the Fed’s official mission is, famously, to boost employment. The notion behind this task – namely that lasting private sector employment can be enhanced through constant money injections and manipulations of interest rates – is utter economic nonsense. However, it is the very raison d’etre of the Fed. That is their line and they are sticking to it.
That QE3 would ultimately come was clear from the moment that QE2 had been concluded. It was only a matter of time. Yet, from the point of view of the central banker, it would be a mistake to simply resume QE without orchestrating first a protracted and well-publicised internal debate. Otherwise, the public could get the idea that modern central banking was simply ‘money printing’ rather than a difficult, complicated, and intricate affair that requires countless economic analysis and careful fine-tuning.
The Fed’s present deliberations seem to go something like this: There is a ‘recovery’ out there, but it does not look ‘substantial and sustainable’ enough. Some higher asset prices, lower interest rates, tighter risk premiums, or more generous bank reserves – preferably, all of the above – could help the economy and make sure that the ‘strengthening’ is ‘substantial and sustainable’. Let’s print more money!
What to expect
I have no insights in what precisely the Fed is up to, and frankly, I find the expert-discussions among analysts on CNBC or elsewhere on the topic slightly degrading and cringe-inducing, akin to watching an episode of ‘I am a celebrity, get me out of here’. Do these experts realize how much we have moved away from capitalism? These financial analysts often call themselves ‘economists’ when what they are doing resembles much more the work of the Soviet-era Kremlin watchers who tried to read between the lines of policy pronouncements and the tea leaves of the Politburo.
For what it is worth, my guess is the Fed will have to do more than the lame $600 billion they did last time. And at some point they will have to also stop paying interest on the massive excess reserves at the Fed to push more money into the economy.
What will the consequences be? Will this be the straw that breaks the camel’s back? Will it push the financial system over the edge? Will it finally undermine confidence in the system? Will this trigger sell-offs in bonds and trigger currency meltdown? – I doubt it. Not yet. We may have to wait a tad longer for this. But it will undoubtedly add to the grave distortions in our financial system. The Fed’s chosen assets will get a temporary boost, some well-connected financial firms will make handsome windfall profits, and some of the economic data might improve for a while. I also think that the deflationists out there, who expect balance sheet shrinkage and drops in asset prices, will again be disappointed. Another dose of Valium will probably keep asset prices supported and also consumer and producer prices on an upward trend. All this new cash has to go somewhere. The debasement of paper money will continue. Gold could do well.
Naturally, none of this will end the crisis. It will certainly not kick off a ‘virtuous cycle’ of growth and prosperity such as Bernanke foolishly promised back in 2010 when he last engaged in QE. That this is the one ‘stimulus’ that will finally put the economy on self-sustaining growth, on the ‘substantial and sustainable strengthening’ the Fed demands, is grotesque and simply laughable. This policy will simply cement the dislocations and add more debt to our economies. It could inflate the government bond bubble – the most dangerous of all bubbles – further, and allow the US government to run even larger deficits for even longer (although, admittedly, the bond bubble continued to inflate even in the absence of QE, due to private sector ‘safe haven’ flows, although the bubble has also been supported continuously through zero interest rates and ample bank reserves, both provided by the Fed). The financial system will, on the margin, become even more dependent on ongoing Fed support and ultra-low policy rates. This will make it impossible for the Fed to ever reverse course.
The idea that all this monetary madness is only temporary, only to help us get out of the crisis, and that the central banks have an ‘exit strategy’ -a term that I have not heard or seen in any discussion of central bank policy since spring of 2011! – is getting less tenable by the day. There is no exit strategy. Not in the US, not in the UK, not in the Euro Zone.
In Britain, the ex-central bankers Blanchflower and Posen are demanding that the Bank of England, the global QE champion, drops its ‘anguished religious ethics’ over QE and finally buys a wider range of financial assets, and not just government bonds. Germany’s Spiegel-magazine this month reported that the ECB might establish upper yield spreads for non-German government bonds and then defend them through its own open-market bond-buying. Wherever you look, the same story: More money has to be printed in order for the central bank bureaucracy to influence, distort and manipulate an ever wider range of asset prices.
One day a sufficiently large section of the public will realize that the central bank and the government have no alternative to printing ever more money and taking on ever more debt. The only way they know of how to ‘stimulate’ the economy is via cheapening credit and encouraging more lending and borrowing. At some point, confidence will evaporate, people will disengage from bonds and paper money, inflation will rise (as money becomes a hot potato) and real interest rates rise even faster (as bonds become hot potatoes, too). Nobody knows when that will be. But we know one thing: the policy bureaucracy remains relentless in its efforts to make the widespread price distortions, capital misallocations and the gargantuan debt pile bigger. More interventions and market manipulations are on the way. All of them are designed to discourage the liquidation of imbalances and instead encourage more debt accumulation. The goal seems to be to make the endgame as catastrophic as possible.
That is the one thing the central bank bureaucrats and politicians will succeed in.
20 Responses to More QE is on the way – The central banks are digging themselves a deeper hole
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{ Re: "inflating the debt away cannot work", "look at Japan" etc. I don't quite follow,... } – May 22, 4:00 PM
{ You raise some very good points that go slightly beyond what I was trying to... } – May 20, 9:47 AM
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Welcome back! Thanks for continuing to write Detlev. Your voice of sanity is much needed.
Dear Detlev,
Your work here is incredibly generous and noble. I would assume that most people have no problem with you taking some downtime in Northern Hemisphere summer to enjoy some time off with your family. I would also assume that people that read your blog are nothing but thankful for your insight and tireless work and information you provide here free of charge.
Hopefully the little protection that people may seek will be enough to get themselves and their families through this disaster in progress.
Kindest of regards,
Peter.
Will this trigger sell-offs in bonds and trigger currency meltdown? – I doubt it. Not yet. We may have to wait a tad longer for this.
YOu mean we still have to wait what another 5 years ? 10 ? 20? lets face it you know nothing at all, this writer will and has been writing the same rubbish every year.
Hello Mark,
I have heard that there was an incredible Stock Market crash in October of 1929, and a decade long depression ensued. And I get the idea that “nobody saw it coming”.
I wasn’t alive in 1929 or during the Great Depression. Does that mean it didn’t happen? I don’t know, I “know nothing at all”.
Maybe when it it actually happens to us, and it’s something we never saw coming, then we will know something.
Would I be better off if I started preparing now if I believe that I see something coming? It may come down to… what you believe in. Personally, I don’t believe that Government and it’s partner banking cartel should be in control of the money supply, the interest rate, and how much debt there is(and then foist massive amounts of it onto the people/public). When the interest rate, which is the price of money, is artifically manipulated and set at or near zero through the use of force and/or corecion of The State, guess what the Central Bank is saying that your paper money is worth?
I believe I’m being turned into a debt slave without my consent. I also believe I might see something coming, and I choose to do something about it.
Regards
To my memory, Detlev has never laid claim to a particular time constant, only to the inevitability of the coming crisis, whenever it might arrive. One need not know around which bend of the river the waterfall awaits, but the distant roar is unmistakable. Ignore it at your own risk.
Mark – if you take the time to read Detlev’s book you will see that he knows a fair amount, and rather more than most ‘economists’ pedalling their wares on TV and in the newspapers (or indeed working for the central banks or government).
Timing the end game for the present financial system is hugely difficult, but the main facts of the degradation of the unit of purchasing power unlinked to any commodity base is already evident and growing inexorably, so the eventual end game is a very high probability and one worth making some preparation for. If you choose not to that is entirely your decision. That is at least one operation of the capitalist system that will operate with beautiful simplicity come the time.
Awesome article, I believe that what you say in your book and in your articles will become common knowledge a few years from now. Your merit is being able to understand what’s going on and explain the reasoning and the outcome as you do. As people’s perceptions aren’t predictable, it is impossible to time the collapse, but it’s inevitable. Many thanks for your great work.
The air around here was getting stale without you. Thanks for another breath of the fresh stuff.
ECB does not create any money. The ECB expands it’s balance sheet by borrowing from the Fed (see the agreements on 29.Nov.2011 in Washington D.C.)
= = =
But how about CHANGING the system?
Monetarism
Monetarism is the system where a private entity issues public currency as a debt. If all this debt would be paid back, the monetarist money would be fased out the economy, leaving it without any currency, nor cash nor electronic. And there would be no other money to pay the interest because the currency quantity for interest coverage has never been created. This is the design of the current money system. It is called monetarism, is the actual money system of the West and is mathematically impossible to sustain.
The system itself cannot survive the very numbers it is generating.
Thus the problem is the system.
By design this system is crushing the physical economy just like a tumor is killing a living body. The economy is collapsing and with it the monetarism is collapsing as well. Just like a tumor killing it’s victim: victim dead, cancer dead.
Sovereign Currency
The alternative is sovereign currency. The state (as opposed to a private entity) has the monopoly of issuing the currency. The crucial conditions:
o all money mass MUST have coverage in the physical assets of the economy of the nation.
o Controlled Exchange Rates: all national currencies MUST be bound by a worldwide foreign currency exchange agreement in order to block speculation.
In this case the money is not a debt to a private entity, but a CREDIT from the true national bank (100% owned by the nation) to the physical economy of the nation. By law the central government component of the state will be forbidden to be loaded with debt, it will only have credit.
We should replace the monetarism with a system of national credit also known as sovereign currency.
Some research: “Secret of Oz”, “Thrive The Movie”
[...] Schlichter comes back from Africa to see that the financial world is in an even deeper hole than when he [...]
[...] article was previously published at Paper Money Collapse. Detlev S. Schlichter is a writer and Austrian School economist. He had a 19-year career in [...]
What a great blog! Thank you very much for sharing this thoughts.
IMHO, your idea of isolating government from banking (by selling central banks to private banks) is the idea that should be EMPHASIZED because it is the natural way of doing capitalism and letting MARKETS optimally decide what money to spend and how to allocate it optimally. Once we understand that any solution starts with this rule, we should start thinking about a way to implement it. Just protecting ourselves from the collapse (buying gold for example) is imo really selfish.
Besides, there is one point that I modestly want to add to this proposal: we should FORBID INTERESTS (or usury) on loans. And we can find many arguments for this. interests are the reason why “the world economy” seeks growth in an exponential way that is going to explode one day for at least a reason : resources on earth are limited and cannot grow exponentially. And in my opinion, this is also why governments were forced to abandon the gold standard because the exponentially growing amount of money needed is contradictory with a limited amount of gold available.
I would be glad to have feedback on this subject
I think you are wrong on the topic of interest. It would be foolish to ban the charging of interest. You said yourself, that it would be a good idea to get the government out of monetary matters altogether. You cannot separate state and money and then ask the sate to ban the charging of interest.
Even more importantly, interest is an integral part of human action. If you act, you want something, and wanting something ALWAYS means wanting it sooner rather than later, all else being equal. This is called time preference and it is not psychology but logic. If I am indifferent as to whether I drive my car today or tomorrow, it means tomorrow I am indifferent as to whether I drive it then or the next day, and so forth. It means I am indifferent as to whether I drive the car at all. Thus, driving the car is not ‘a good’ for me, I don’t really want it. But if you want something, you always want it sooner rather than later (all else being equal). That is time preference. Owning a car today is not the same as owning a car (even the same car) in a year’s time. Therefore, the car today has a higher value than the same car in a year’s time. The difference in (originary) interest, which is the basis of the interest rates we observe in markets.
Therefore, nobody will lend you money if, in a year’s time, you only pay back the same notional amount, even in a world in which the purchasing power of money was absolutely stable (no inflation, no deflation) and even if there were no risk of you going broke. Even without any risk premium for inflation or credit risk, I would still charge you interest, because holding money in my hand today is more valuable than holding the same amount of money in my hands in a year’s time. That is time preference and it is universal.
I understand that Islamic law forbids the charging of interest but to my knowledge there are then usually other features built into the loan deal by which the lender gets compensated. Again, time preference is a universal part of human action.
You are also wrong about why gold was replaced with fiat money. Governments were not forced to do it, they chose to do it. A growing economy does not require a growing stock of money. Please read my book on this topic (and also on the topic of time preference and interest.)
We are not running out of resources. Of course, most resources are limited, that is why they have prices. As certain resources become scarcer, their prices go up, which provides an incentive to economize on them and to find alternatives. You should not confuse resources with wealth. Wealth is man-made. There are no meaningful limits to how humankind can combine existing (limited) resources to create wealth; there are no limits to human ingenuity and therefore no limits to wealth creation. At least for the next thousand years or so, I wouldn’t worry.
Welcome back! Good to read a new piece from my favourite blog.
You say “people will disengage from bonds and paper money, inflation will rise (as money becomes a hot potato) and real interest rates rise even faster (as bonds become hot potatoes, too).”
It’s an interesting question whether interest rates would be expected to keep pace with or even outstrip inflation. But my guess is that they would be likely to lag behind, rather than keep up.
Historically, interest rates in the UK during the latter part of the 19th century (i.e. the classical gold standard) were generally in the low single figures (2-3%) with occasional brief forays into high single figures. Since inflation during that period was essentially zero, those were real interest rates.
In the high inflation 1970s, inflation was in double digits between 1974 and 1981, peaking at 24% in 1975. Interest rates were also high during this period but my impression is that they tended to lag behind the inflation rate. The real interest rates would therefore have been negative. So savers would have lost out.
However, I cannot find any UK Treasury yield figures for that period and I don’t know what the mechanisms of monetization were in the 1970s.
Also, I can certainly see that if US and UK sovereign debt became a hot potato, that process could happen very quickly with the result that interest rates could rise very rapidly in a very short space of time.
Hmmmm… dunno ……
Best regards
David
Detlev,
Robin Banerji of the BBC has written today (Aug 30) a piece on the perils of returning to the gold standard. He reviews some compelling difficulties in having the US adopt a gold backed currency. He cites Rogoff.
Would you be able to share your opinion in response to those points raised?
Its titled: ‘Gold Standard: Could it return in the US?’
Thank you, R
Surely the easiest way to keep government spending and borrowing in
check is to pass into law a requirement to balance the budget. I
believe Ron Paul is an advocate of this policy.
Detlev’s reluctance to put a date on the crash that is coming is
understandable. One thing we all underestimate is the ability of
politicians and bankers alike to create schemes and devise plans to
postpone the inevitable.
But for those who are still curious, two people in the public eye have
decided to put a date on the endgame. The American Economist and
broadcaster Peter Schiff says he believes it will be 2013 or 2014. The
investor Jim Rogers says 2014. Only time will tell!
Peter Schiff isn’t an economist. And I have to agree putting a date on anything is a stupid mistake Keynesian economist love to make. It’s impossible predicting the interactions of millions of economic variable, let alone throwing in the perceptions of billions.
Detlev,
Following up on Hamza87′s criticism of interest, and your standard Austrian defense of it:
The necessity of the principle that “wanting something ALWAYS means wanting it sooner rather than later” is perhaps more immediately grasped by contemplating its converse: that *not* wanting something necessarily means wanting it to occur later rather than sooner.
For example, if one didn’t *not* want to have a tooth drilled, one would be indifferent as to when that drilling takes place. For “bads” of this sort, it is the immediacy that imposes a cost, not the waiting. One would pay (as opposed to asking for payment) to delay–a price that reflects “dis-interest”.
Whereas *time preference* (really, present preference for goods one wants) would be reflected in answers to such questions as “Would you prefer to receive 15 pounds in 3 days or 45 pounds in 3 months?” [empirically, it's about 50:50], what might be called *time deferrence* (really, future preference for bads one unwants) would be reflected in answers to such questions as “Would you prefer to lose 15 pounds in 3 days or 45 pounds in 3 months?”
It’s interesting to speculate on how time preference and time deferrence–although both must praxologically exist to some degree with respect to wants and unwants respectively–might not be strictly symmetrical in their psychological magnitude.
I suggest that time deferrence exceeds time preference: people will, when a gain beckons, be more likely to forego a present good for a future good, than they will, when a loss looms, to endure a present bad instead of a future bad.
Incidentally, the idea of time deferrence is quite in keeping with Mises’s frequent characterization of human action being driven by a desire to reduce “felt uneasiness” rather than to increase experienced pleasure.
Very good points. Thanks for that.
Thanks for such clarity!