|Our monetary system is guaranteed to collapse. The central banks prints money like there is no tomorrow. The governments spends like a drunken sailor and yet inflation is benign and interest rates sit at generational lows. Banks are gaining in profitability while their bad debts are being erased by rising asset prices. What’s not to like? Plenty! This article goes into the details of the money creation process to understand how and why this is happening, what the future implications will be and how to best invest to protect oneself from these eventualities.
The above introductory comments are edited excerpts from an article* by Harry Richardson as posted on GoldSeek.com under the title The Road to Hyperinflation.
The following article is presented courtesy of Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.
Richardson goes on to say in further edited excerpts:
Put simply, what we call money is usually created in a three step process.
In order to create money, central banks can also buy assets. In theory any productive asset would do, but in practice central banks usually buy their own governments bonds. The US Federal Reserve buys mainly US T-bonds; the Bank of England buys British Government “Gilts” and so on. This is partly for political reasons (paying off the Government for allowing them to print money) and partly for economic reasons.
In financially stable countries, Government bonds represent the most secure financial assets on offer, backed as they are by the ability of the state to raise money through taxes. If the nation is doing ok, you can be sure the Government will be doing just fine. In normal times, these purchases of bonds are not direct purchases. That is to say, they occur in the secondary market.
The bonds have been purchased initially from the Government by banks, institutions or even private individuals and are then resold in auctions.The central bank buys (or sells) bonds in these auctions to create or retire money. By doing this, the Central Bank is able to manipulate interest rates.
Higher demand for bonds raises prices. Since each bond pays a fixed amount of interest, when its value goes up, the interest rate drops. For instance, if a bond pays $10 per year and its value is $100, then it pays 10% interest. If the price of this bond were to double to $200, since its interest payment remains at $10, it now pays just 5%. In order to raise interest rates, the central bank does the opposite. They simply sell bonds at auction and retire the cash which is raised, withdrawing it from circulation. With more bonds on offer, prices drop, and interest rates go up. Remember this, it is important.
During the early stages of credit expansion,
The stated goal of most central banks is to find a rate which gives reasonable growth, without runaway inflation.This is the reality in which most central bankers have lived their lives. It is also the prism through which they see monetary policy. However this is a false reality which can only exist during the early stages of credit expansion.
As time goes by the forces of deflation gather strength. This leads to:
At this point, the central bank has only two choices:
By borrowing and spending on an unprecedented scale, Western Governments have:
In earlier stages of the credit cycle, whipping boy behaviour of government was kept in check by the “bond vigilantes” – large private holders of government bonds who are inclined to sell them when they see governments running unsustainable deficits. These bond holders know that governments will not have the ability to repay these bonds with anything like sound money so their selling of bonds raises interest rates, forcing governments to rein in spending and repay debt.
After a debt deflation event however, the world becomes a dramatically different place. With credit money disappearing down a deflationary black hole, money printing on an epic scale is required to keep money supply at a stable level.
So here we sit today. The central bank prints money like there is no tomorrow. The government spends like a drunken sailor and yet inflation is benign and interest rates sit at generational lows. Banks are gaining in profitability while their bad debts are being erased by rising asset prices. What’s not to like?
Well, if you aren’t one of the lucky ones with real estate and a healthy share portfolio, things are not so good.
Clearly this is not a sustainable model. It can however continue for quite some time… Unfortunately, we do know that if something can’t go on, it will eventually stop. The sixty four million dollar question is when? (and how?).
Nobody knows for sure of course, but I wanted to lay out my own prediction for a possible series of events which could bring the system down.
This is the result central banks have been looking for. They see it as a return to the good old days, pre-crisis and I am sure they are currently all patting each other on the back and heaving a huge sigh of relief. This sense of relief may well turn out to be somewhat premature however as a couple of niggling problems point to things not being quite what they seem.
Printing money will therefore need to be continued to keep the system going. Recent talk of “tapering” means that either:
Whichever path is taken, more money printing is the final destination, but so what? Japan has been following this path for years with still no sign of rampant inflation.
Many wise people think something will go wrong. Any number of possible flash points exist, but here is my own prediction for how it might happen:
Japan has been at this game longer than anyone else, so it may well be the first to come undone. Recent policy by the Japanese government and central bank has been to aggressively target inflation of around 2%. This is hoped to stimulate the economy, weaken the yen and make exports more competitive. Presumably this has been done through bulk buying of Japanese Government Bonds (JGB’s) by the central bank.
In April this year (2014) the Japanese Central Bank stopped buying JGB’s for one and a half days. During this period, not a single bond was sold. With yields near zero percent and inflation targeted at 1.8% this is hardly surprising. It does, however, give a hint of a very scary possibility in the near future.
When central banks target an inflation figure, they often overshoot. Monetary policy is not an exact science and actions taken now are not felt for six months or more. Inflation in Japan has just reached 3%, well ahead of its target. Expectations would be for the Japanese Central Bank to begin tightening, but how? In normal times, the bank would begin selling its portfolio of government bonds. Since the central bank now owns the entire bond market, who is going to buy? No one at these prices apparently.
To drop prices substantially to reach a market rate, however, would set off some potentially cataclysmic consequences.
There is another [better] way the central bank could reduce money in circulation. Having spent the last 20 years receiving capital injections from the Central Bank, the commercial banks are likely to want to lever up these central bank reserves by lending to speculators. In order to limit this, the central bank could:
In this way, a crisis in Japan could quickly morph into a crisis in the US treasury market leading to an explosion in QE.
After all the talk of “tapering” this would have a very significant psychological impact on perceptions of the US Dollar and treasury strength. With other significant holders of US Government bonds in Asia and the Middle East selling, the Fed would be forced to buy (monetise) these bonds with freshly printed dollars, which would, by this stage, be depreciating rapidly.
People will still need money to be able to survive. Not only people, but businesses, governments and institutions will need some form of money to conduct essential business. If this situation became reality, only two currencies (gold and silver) would hold value, because these are the only currencies which can’t be printed by central banks.
Invest and insure your wealth accordingly.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
*http://news.goldseek.com/GoldSeek/1404482400.php (© GoldSeek.com, Gold Seek LLC)
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