By Alasdair Macleod
This article asserts that infinite money-printing is set to destroy fiat currencies far quicker than might be generally thought. This final act of monetary destruction follows a 98% loss of purchasing power for dollars since the London gold pool failed. And now the Fed and other major central banks are committing to an accelerated, infinite monetary debasement to underwrite their entire private sectors and their governments’ spending, to prop up bond markets and therefore all financial asset prices.
It repeats the mistakes of John Law in France three hundred years ago almost to the letter, but this time on a global scale. History, economic theory and even common sense tell us governments and their central banks will rapidly destroy their currencies. So that we can see how to protect ourselves from this monetary madness, we dig into history for guidance to see who benefited from the Austrian and German hyperinflations of 1922-23, and how fortunes were made and lost.
The way inflation is commonly presented by modern economists, as a rise in the general level of prices, is incorrect. The classical, pre-Keynesian definition is that inflation is an increase in the quantity of money which can be expected to be reflected in higher prices. For consistency and to understand the theory of money and credit we must adhere strictly to the proper definition. The effect on prices is one of a number of consequences, and is not inflation.
The effect of an increase in the quantity of money and credit in circulation on prices is dependent on the aggregate human response. In a nation of savers, an increase in the money quantity is likely to add to savers’ bank balances instead of it all being spent, in which case the route to circulation favours lending for the purpose of industrial investment. Product innovation, more efficient production and competitive prices result; and a price countertrend is introduced, whereby many prices will tend to fall, despite the increase in the money-quantity.
We see this effect in electronic and other goods emanating from savings-driven economies in East Asia, notably Japan and China. But in economies where savings have been discouraged, particularly in America and the UK, there is less investment in production and a greater emphasis on imported goods. Immediate consumption dominates, and increased quantities of money in consumers’ hands inevitably lead to a rise in the general price level of commonly demanded consumer goods.
In a world-wide fiat currency collapse, different savings characteristics between nations can be expected to lead to variations in the speed and timing of the decline of purchasing power between different currencies. We address this point later in this article and the consequences thereof. But a more immediate difficulty for observers is the habit of unquestionably accepting government measures of the general level of prices and incorrectly calling it inflation.
Don’t trust government inflation statistics
The general level of prices is one of those economic concepts that cannot be measured. The policy of targeting a general level of prices through broad-based indices such as the CPI is thereby fatally flawed. The fundamental and incorrect assumption behind the concept of a consumer price index is that future demand does not vary from the historic, in other words the economy evenly rotates, and economic progress is banished from our thoughts.
Furthermore, the broader the index, the more that extraneous factors, such as import substitution undermines the statistical concept of indexing domestic consumer prices. Together with the state’s desire to reduce the apparent rate by using methods such as hedonics and product substitution, it explains why a CPI can rise at an average annual rate of just under 2% seemingly in perpetuity, while a more targeted index that focuses on everyday items, such as the Chapwood index comprised of 500 constant items, has returned an approximate 10% annual rate of price inflation for a number of years. And if you remove the distortions introduced by government statisticians over the last forty years as demonstrated by Shadowstats, you get a similar 10% approximation.
What matters more than statistics is the effect on ordinary people. In their lack of knowledge about the consequences of changes in the quantities of money and bank credit, by default they see money as a constant, an objective factor in their transactions, with all the price changes emanating from the goods and services being bought or sold. They put rising prices down to profiteering, and when they fall, particularly for goods where product innovation is a strong influence, it is either explained by cheap foreign labour or just taken for granted. There is no public understanding of how inflation undermines the money side in transactions, nor, for that matter, how inflation transfers real savings and earning power from the individual to the state, which is the unstated objective of modern monetary policies.
It is ignorance of the role of money in this regard that permits governments to finance a significant and growing portion of their spending without resorting to unpopular taxation. Government debt issuance, which masquerades as a promise to repay the money borrowed, is mostly inflationary, sourced through monetary and bank credit expansion, that is when savers do not increase their savings. And in the desire to promote current consumption, American and British nationals in particular have been encouraged to spend all their income on consumer goods instead of adding to their savings.
The recycling of capital from trade deficits into government and other securities is inflationary as well. When foreign businesses in the import trade or their governments buy a state’s government debt, the origin of their currency purchased can almost always be traced back to domestic credit expansion. American trade deficits since 1992, having accumulated to $12 trillion matches foreign ownership of the sum of US Treasuries, asset-backed securities and short-term debt almost precisely.[i]
Given proclamations by central bankers that they are about to hyperinflate, ignorance of monetary matters becomes an expensive condition. When trying to understand money, credit and how they flow, the vast majority of people find themselves in an Alice in Wonderland confusion where nothing makes sense. They are setting themselves up to lose everything they possess.
The first phase of inflation is ending
For most people the persuasive argument is empirical evidence, assuming they are prepared to look for it. We all understand that over time, our dollars, pounds and euros buy less. But despite the evidence, almost no one is really aware of the extent their fiat currencies have declined.
I make no apologies for having used the chart in Figure 1 before, but it is necessary to ram the point home. Since the dollar was devalued from $35 in the late 1960s, measured against gold the dollar has retained only 2.2% of its 1969 purchasing power. Admittedly, one would expect gold’s purchasing power to gently rise over time, which has been the experience under gold standards, exaggerating the dollar’s decline.
But critics of the approach of measuring fiat currencies against gold should note that measured by broad money (M3) only 3.8% of the dollar’s 1969 purchasing power remains, and when the increase in bank reserves not in circulation is taken into account, the figure falls to 3.2%, much closer to that indicated by comparison with gold. The inclusion of bank reserves, reflected in the fiat money quantity, is illustrated in Figure 2, and shows that the increase in the money quantity has recently become vertical.
The rapid monetary expansion before 1 March (the most recent available underlying statistics), was before the US lockdown and has continued since. So far, this has been only Phase 1 of the decline of fiat currencies, the warm-up act for a total currency collapse, which we will call Phase 2. It is increasingly certain with every passing day that we are now embarking on that second phase, which is now the focus of this article.
The second phase – currency destruction
With the general public and virtually all the financial establishment ignorant of or blind to the inflationary situation, central banks have chosen this moment to announce unlimited monetary expansion to buy off the consequences of the coronavirus. They have committed to the virtual nationalisation of their economies, to be paid for by debauching their currencies. The process depends on public ignorance of the consequences. In all the announcements of government support for their economies and of their central banks’ monetary role, there has been virtually nothing said or written about the consequences of the monetary inflation involved.
Indeed, the only thing more astounding than the ignorance of the general public over monetary matters is the apparent ignorance of the politicians and central bankers charged with implementing monetary policy. But the brakes are now off, the chasm beckons, and the purchasing powers of fiat currencies are set to run downhill at a rapidly accelerating pace. We are now about to embark on Phase 2, when it dawns on the public that with respect to prices money is collapsing and will soon become worthless.
The process of a developing collapse of a fiat currency usually starts with foreigners reducing their exposure to it. In the case of Austria and Germany in 1922-1923, foreigners sold the crown and the paper mark respectively for dollars freely convertible into gold. In John Law’s day, it was astute speculators who could sense a failing project and whose selling of his Mississippi venture and Law’s unbacked livres for foreign currencies and specie overwhelmed Law’s plans. Today, both cross-border strategic positions and portfolio investment are stalling and threatening to reverse. Ahead of the event it is impossible to judge their sequencing; but the dollar having the role of reserve currency appears to be most exposed to foreign liquidation, with foreigners holding equities, boned, deposits and cash totalling some $25 trillion, significantly more than America’s GDP.
To address their escalating liabilities at home, foreign governments and businesses will require financial resources currently invested in US securities to be repatriated. Foreign central banks have their own economies to rescue. Businesses everywhere are suddenly facing mounting losses and have no alternative but to reduce their dollar exposure. Foreign portfolio managers are being spooked by a developing worldwide bear market and seem certain to liquidate their US holdings and their dollar positions in the coming months.
Diminishing cross-border trade and the shock of the coronavirus have fundamentally undermined demand for dollars. This is not to be confused with demand for dollar liquidity, which some say will support the dollar. Liquidity is required in all currencies, which will be satisfied by liquidation of financial assets. The ensuing collapse of financial asset values and foreign liquidation of dollars is increasingly likely because all classes of foreign investors have, until now, enjoyed the security of investing in the world’s reserve currency, while Americans have generally avoided owning foreign currencies. It is only a matter of time before this imbalance begins to undermine the dollar, and then consequences will follow.
The dollar problem has arisen partly because interest rates are too low. The comparison is not to be made against negative rates in other currencies, but in the context of the domestic US economy. From rising food prices, deteriorating government finances and falling stock prices, other factors will flow. Bond yields, which cannot fall by much, will begin to rise as the government deficit increases, particularly with foreign buyers for US Treasuries being absent. Inevitably, the Fed will then come under pressure from markets to raise interest rates. In the face of an economic slump this will be resisted, and the exchange rate will fall. As the banker of last resort for the US government, the deteriorating economy, and for the rest of the world, the Fed will not only be financing everything but forced into buying bonds the foreigners and others sell as well.
On both Wall Street and Main Street, Americans are bound to become increasingly aware of the inflationary consequences. The problem for the Fed is that there is no Plan B alternative to financing by means of inflation of money and credit, particularly in an election year.
After a persistent and unusually protracted period of monetary inflation over the last fifty years, it is increasingly likely the public will finally understand what is happening to prices. They will then begin to realise that it is excessive quantities of money in circulation that is the reason for rising prices, and that they must dispose of currency as quickly as possible for anything they want or can barter in future for something else. Empirical evidence is that this second and final phase of monetary debasement is likely to last only a matter of months.
Once this second phase starts, it is almost impossible to stop it, because the public will have lost faith not just in the currency, but in the government establishment’s monetary and economic policies as well. It ends when an unbacked fiat currency is no longer accepted as money by the public.
In the past, an inflationary collapse has usually affected currencies in isolation; but the modern tendency for governments to coordinate their inflationary stimulations raises a new factor, of strains between currencies collapsing at the same time but at different rates.
The most notable experience of it in modern times was in several European countries following the First World war. The inflations were individual to the nations, but the cause was the same, and Austria’s inflationary collapse ran ahead of Germany’s. A passage from a man who witnessed it, the Austrian writer Stefan Zweig, in his autobiographical The World of Yesterday vividly describes the consequences:
Every hotel in Vienna was filled with these vultures [foreign tourists]; they bought everything from toothbrushes to landed estates, they mopped up private collections and antique shop stocks before their owners, in their distress, woke to how they were being plundered. Humble hotel clerks from Switzerland, stenographers from Holland would put up in the deluxe suites of the Ringstrasse hotels. Incredible as it may seem, I can vouch for it as an eyewitness that Salzburg’s first-rate Hotel de l’Europe was occupied for a period by English unemployed, who, because of Britain’s generous dole were able to live more cheaply at that distinguished hostelry than in their slums at home. Whatever was not nailed down disappeared. The tidings of cheap living and cheap goods in Austria spread far and wide; greedy visitors came from Sweden from France; more Italian French Turkish and Romanian was spoken than German in Vienna’s business district.[ii]
Among the Austrians impoverished in their own communities, the law-abiding starved and those prepared to break food rationing laws thrived. Savers, who had patriotically bought government bonds, lost everything. Germans from across the border, whose currency was yet to enter its final collapse, could swill six litres of Austrian beer for one of German, adding to the foreign revelry in Austria’s misery.
In our contemporary fiat collapse, differences in its rate will create similar openings for an unsettling life arbitrage. In business dealings, any vestiges of decency and compassion are early victims as those with an early understanding of the opportunities provided by a monetary collapse profit from the innocence of the ignorant. But Germany was to suffer the inflationary fate of Austria the following year. Again, from Zweig:
A pair of shoe laces cost more than a shoe had once cost, no, more than a fashionable store with two thousand pairs of shoes had cost before; to repair a broken window more than the whole house had formerly cost, a book more than the printers shop with a hundred presses. For $100 one could buy rows of six-storey houses on Kurfürstendamm and factories were to be had for the old equivalent of a wheelbarrow…
…Towering over all of them was the gigantic figure of the super-profiteer Stinnes expanding his credit and in thus exploiting the mark he bought whatever was for sale, coal mines and ships, factories and stocks, castles and country estates, actually for nothing because every payment, every promise became equal to naught. Soon a quarter of Germany was in his hands and, perversely, the masses who in Germany always became intoxicated at a success that they can see with their eyes, cheered him as a genius.
The story of Hugo Stinnes brings us back to our current situation, how markets will evolve and who will profit.
The fate of financial investments
All the intentions of providing business with credit, helicoptered money, replacing lost taxes and ensuring government is financed, can be pared down to a single policy objective: the support of financial asset values. If the markets fail, all else fails.
In today’s fiat currency world, the principal asset from which all others take their valuation is government debt. But that has run out of road, with US Treasury debt yielding less than one per cent for all but the longest maturities, and in Europe, Switzerland and Japan unnatural negative rates are common. Foreign ownership of US Treasuries and other financial assets, which has long been the counterpart of trade deficits and portfolio inflows, is now greater than the US’s GDP and will almost certainly become a source of funds for foreign governments, businesses and investment portfolios in difficulty themselves.
Commercial banks are in a mood to contract their balance sheets, initially due to liquidity constraints and now increasingly driven by abject fear. With demand for new government debt thereby limited, the Fed, together with central banks in other jurisdictions, will find that they are effectively the only significant actors on the buy side for not just government debt, but a wider range of financial assets as well.
The Fed has already stated it will offer additional support to bond markets by buying exchange traded funds invested in corporate bonds. By putting a floor under bond spreads, the Fed obviously hopes to support everything from junk to investment grade, because if it did not, spreads would blow out even more, threatening bank balance sheets which are thought to carry some $2 trillion of this debt both directly and in collateralised loan obligations.
The Fed already supports house prices by buying mortgage debt. It hopes that by preserving a wealth effect, investors will not only continue to feel well off but be encouraged to keep investing. The policy is to swamp financial markets with new money. The other side of the Fed buying financial assets of any description is the payment for them, expanding the quantity of money in circulation.
The overwhelming imperative to keep control of markets is a recipe for hyperinflation and will ultimately fail. The Fed would have us believe that the slump in business activity is only due to the coronavirus lockdown and that shortly after it ends normality will return. It will hope that we have forgotten that fully five months before the virus hit, it was forced to inject liquidity into the repo market at the rate of tens of billions every day.
The Fed’s monetary policy replicates John Law’s attempt to keep his bubble going in 1720 France. Law failed to maintain the price of just one asset, the Company of the Indies, his Mississippi venture, by printing livres to buy the shares. Within seven months the currency had collapsed and priced in worthless currency, the shares had fallen from 12,000 livres to just one or two thousand.
The principal upon which the Fed and the other major central banks are embarked is the same in every respect, but with a far larger task. The project will fail for the same reason: no one can fool all of the people all of the time. It is increasingly obvious that both the currency and financial asset values will collapse John Law-style, probably by the end of this calendar year, if precedents are any guide.
There will be economic turmoil, with businesses and their banks collapsing, for which yet more quantities of money will be required to discharge the socialistic imperative. There will be a new currency, whether it is an attempted government reset which will only delay the ending of fiat currency for a few more months, or one that evolves from gold or silver and their credible substitutes.
Those seeking to profit from the situation will emulate the Inflation King, Hugo Stinnes, who bought real, instead of financial assets. As Zweig put it in the second extract quoted above, whatever was for sale, coal mines and ships, factories and stocks, castles and country estates, actually for nothing because every payment became equal to naught. But among financial assets, there could be shares of businesses that will survive, but stock markets being dependent on fiat money will be finished. Thinking that there is some protection from inflation in equities has been true in Phase 1 of the inflationary collapse, the last fifty years to date. But in Phase 2, a sudden global collapse of the fiat currency system, financial assets are probably to be avoided.
By far the best strategy is to have sound money at the outset. When $100 could buy rows of six-storey houses on Kurfürstendamm in Berlin and factories were to be had for the old equivalent of a wheelbarrow, the dollar was gold-backed. Today, with all currencies set to collapse there are no substitutes for gold itself, the only exception being silver. A case could be made for bitcoin, and other restricted-issue distributed ledger cryptocurrencies, but is yet to be proven. The adventurous will borrow fiat to buy bullion today, in the expectation the fiat repayment will cost them nothing. And what better opportunity is the gift presented to present day inflation kings than the suppression of interest rates by central bankers.
[i] Source: US Treasury Preliminary report on foreign holdings of US securities at end-June 2019
[ii] Zweig probably erred in his description of English unemployed spending their dole in Salzburg, and his account of them is disputed by historians. More likely, they were unemployed ex-soldiers who, having survived the war, lived off their meagre savings to the best advantage. More to the point, the opportunity provided to them by the collapse of the Austrian currency could have encouraged uncouth behaviour in otherwise civilised people.
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