Paper money collapse is inevitable

September 9, 2011 06:33

[T]he fiat money crisis is not a natural catastrophe. It is entirely man-made. It is the direct consequence of political decisions and political action.

Why Policy Advise Is Futile And What You Should Do Instead

By at Whiskey & Gunpowder

Paper money collapse is inevitable. Our present system of elastic money is not only suboptimal it is also unsustainable. As I show in my book elastic money must lead to the accumulation of imbalances, to capital misallocations, and to resource mis-pricings. Those must lead, over time, to economic disintegration and chaos.

The present system must end, it will end, it will now certainly end badly. And probably soon. As it is inevitable it doesn’t matter what I wish. To wish that this would not happen would be as sensible as to wish that the present summer would not end, and that the days would not get shorter. I don’t wish it and I don’t fear it. The system must go. Good riddance.

What I do fear, however, are the political consequences and the societal fall-out from the crisis, and I particularly fear the responses it will provoke from governments and state officials.

Of course, the fiat money crisis is not a natural catastrophe. It is entirely man-made. It is the direct consequence of political decisions and political action.

In particular, it is the inevitable consequence of the decision to abandon a gold-based monetary system, a system of essentially inflexible and apolitical money, and to replace it with entirely elastic and constantly expanding paper money. This paper money leads to accumulation of imbalances, to capital misallocations, and to resource mis-pricings. Those must lead, over time, to economic disintegration of banks.

It is the direct consequence of the erroneous belief that low interest rates and additional credit are good regardless of whether they are the outcome of true saving and capital accumulation, or simply the outcome of fiat money creation.

There is the unspoken belief that after all my research on the topic I must have some good policy advice up my sleeves. Often people ask me, so what should be done? If what central bankers and politicians are doing presently is, as you say in your book, counterproductive, what should they do instead? What is the solution?

There is an assumption that one cannot simply predict some unpleasant outcome in the field of economics and not offer at least a bit of hope that things may turn out differently. Suggesting the possibility of a way out that would spare us all the painful consequences of past actions, of decades of misguided policy, of cheap credit and limitless money.

I suspect that since I speak so little about specific policy reforms leads people to believe that I don’t care about where we are going, or I might even look forward to the disaster.

What should be done

There is only one possible way out. Stop the printing of money and the artificial suppression of interest rates. Return to hard money. Allow interest rates and market prices to again reflect the true extent of voluntary savings, and to thus allow the liquidation of the accumulated imbalances from previous money expansion.

But because we had a four-decade long period of unprecedented fiat money creation globally, these imbalances are now so big that the necessary liquidation would be very painful. The political class — which got us into this mess in the first place — would never deem it acceptable.

The overstretched banking industry, the overextended asset markets, insolvent governments are all screaming for a cleansing liquidation and recalibration. A crisis has now become unavoidable.

But politicians still think that the power of the state is unlimited, that what they don’t find acceptable will simply not be allowed to occur. Only in the realm of politics is reality optional…somehow reality can simply be made to conform to the wishes of the political elite.

Of course, policy cannot create a new reality. What policy does at the moment is try to postpone the inevitable correction ever further. “Not on my watch” is the modus operandi. This will make the final crisis even worse.

I quoted Ludwig von Mises on this on a couple of occasions but I will do it again. In his magnum opus of 1949, Human Action, the grand master of Austrian School economics said:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

The endgame will be “a final and total catastrophe of the currency system”, and “later” may indeed be soon. Remember, we have been postponing the liquidation for decades and happily piled new debt and new imbalances on top of the old debt and the old imbalances. By not stopping the printing of money and the accumulation of debt and capital misallocations (and by adding to them instead) the policy establishment is making sure that the final crisis will only be worse.

This is why I consider it pointless to come up with policy recommendations. What would be the purpose of presenting a detailed plan of converting to a gold standard, which is what should be done? Mainstream economists, politicians and central bankers will either ridicule or ignore it. They still believe that the answer to all these money-induced imbalances is — more money! They are hell-bent on creating a total currency catastrophe. And they will get it.

A whiff of Weimar Germany

Let’s just take a casual look at the events of the past month: While I was hiking in the Dolomites or relaxing in Tuscany, the destroyers of paper money did not rest. The ECB completed a U-turn of embarrassing proportions and switched from exit strategy to buying more PIIGS-bonds funded by the printing press — a policy that continues to this day and that will not end!

And Dartmouth College Professor and ex-Bank of England money-debaser David Blanchflower argues for more quantitative easing from the Fed. When asked how much, the good professor showed his generous side: $ 1 trillion or $ 2 trillion…just print until things look better. We will show this economy who is boss!

British pundit Ambrose Evans-Pritchard argues that real monetary stimulus hasn’t even been tried yet. He recommends some globally co-ordinated monetary blitz — what if all central banks opened their monetary floodgates simultaneously? Surely, that is going to buy us a nice recovery.

If you thought that this lunacy is being greeted with derision, as it should, think again. As I write this, the Swiss government has declared that international cooperation in monetary debasement is a splendid idea — and has just pegged the Swiss franc, formerly the gold-rimmed version of paper money, to the PIIGS. Congratulations!

Make no mistake: They will all get what they are asking for. But to expect anyone who sees the writing on the wall to engage with a policy establishment beholden to the myth that prosperity and jobs can be had through constant monetary manipulation, through artificially low rates, money printing and asset bubbles — that is asking a bit too much. And let’s face it: it is not as if any of them would even want to listen to what I have to say. I put my case out there — it is for others to decide what to do with it.

Here is another, less well-known quote from the great man, Mises:

“Political ideas that have dominated the public mind for decades cannot be refuted through rational arguments. They must run their course in life and cannot collapse otherwise than in great catastrophes…”

We are approaching such a catastrophe with full force. Rather than coming up with a monetary reform (and there is only one true reform: a return to gold) that will certainly be rejected by the powers that be, I think the most sensible thing one can try and do is to protect oneself, one’s family and one’s wealth as best as one can from the ensuing fall-out.

My recommendation has been and still is to reduce exposure to banks and to governments – the two grotesquely bloated entities that have for decades benefited from their privilege to be unconstrained paper money producers and who are now close to OD’-ing on that privilege. Hold gold (and maybe silver) instead of paper money, bank deposits and fixed income securities. Real assets, not paper assets.

The coming monetary meltdown will wipe out vast amounts of paper wealth, and it will facilitate one of the largest transfers of real wealth in human history. Many people will lose a lot.

Sadly, it will be mainly those who produce more than they consume and who save the difference — and then save it in the form of cash, bank deposits and bonds.

All paper money collapses decimate the middle class. No, I certainly don’t wish for this but the chance of this being avoided is practically zero.

Short of the century — coming soon!

As always, some will win, and there is no shame in trying to be among them. Apart from the rise in the gold price and certain other commodities, I think that there is another money-making (no pun intended!) opportunity: fixed income markets will soon be the short of the century.

Those out there who think the world will be just like Japan for the next twenty years are wrong, in my view. Japan’s present state is not stable and it doesn’t constitute an endgame. It is collapse in super-slow-motion.

The ongoing fiscal deterioration and the mind-boggling accumulation of public debt mean that the ultimate endgame there will be inflation and paper money collapse, too. And I doubt that the U.S. and Europe will manage to stretch this out for quite as long as Japan has.

But here is what I fear.

I am very concerned about the political fall-out from the crisis. Although it will ultimately mark the end of state paper money, of politically controlled interest rates, and government-manipulated asset markets, don’t expect the state to leave the economic stage without a fight.

For the immediate future at least, I expect more interference with markets, more regulation, more confiscation via taxation, capital controls and curtailment of property rights and individual freedom. In a crisis, many will demand more government and more state action, not more freedom and markets.

When I spoke to a libertarian audience in Vulcano I was speaking to friends, to like-minded people. People who, like me, value personal freedom and free markets. I sensed that they, too, would have loved me to give them a bit more of an uplifting message.

Many of these libertarians believe that what they are involved in is simply a battle of ideas, and that they can, if they try hard enough, convince others of the benefits of a free society and of capitalism. I don’t think that this is entirely wrong. But I fear that many of them underestimate the opposing forces that the present crisis may unleash.

In the meantime, the debasement of paper money continues.


Detlev Schlechter

Detlev S. Schlichter (Hampstead, UK) is a writer and Austrian School Economist. Schlichter has a degree in economics and spent nearly 20 years working in international finance, including stints at Merrill Lynch and JP Morgan. He served as a portfolio manager of fixed income portfolios at J.P. Morgan Investment Management and, in 1996, moved to London to work in the global bond team of the company there. In his career, Schlichter has overseen billions in assets for institutional clients around the globe.


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