Best of the Week
Most Popular
1. Stock Markets and the History Chart of the End of the World (With Presidential Cycles) - 28th Aug 20
2.Google, Apple, Amazon, Facebook... AI Tech Stocks Buying Levels and Valuations Q3 2020 - 31st Aug 20
3.The Inflation Mega-trend is Going Hyper! - 11th Sep 20
4.Is this the End of Capitalism? - 13th Sep 20
5.What's Driving Gold, Silver and What's Next? - 3rd Sep 20
6.QE4EVER! - 9th Sep 20
7.Gold Price Trend Forecast Analysis - Part1 - 7th Sep 20
8.The Fed May “Cause” The Next Stock Market Crash - 3rd Sep 20
9.Bitcoin Price Crash - You Will be Suprised What Happens Next - 7th Sep 20
10.NVIDIA Stock Price Soars on RTX 3000 Cornering the GPU Market for next 2 years! - 3rd Sep 20
Last 7 days
Amazon AMZN Stock PRIMEDAY SALE! Trend Analysis - 20th Apr 21
Stock Market Sentiment Speaks: You May Not Believe My 2021 Targets - 20th Apr 21
Stock Market Phase Two Projection - 20th Apr 21
Are Precious Metals & Miners Starting A New Longer-Term Bullish Trend? - 20th Apr 21
Inflation: First the Gain, Then the Pain… - 20th Apr 21
8 Stock Market Indicators in 1: Here's the Message of the Panic/Euphoria Model - 19th Apr 21
Gold - You Can Win a Battle, but Still Lose the War - 19th Apr 21
Will Interest Rates Rally Further Push Gold Price Down? - 19th Apr 21
Gold Fireworks Doubt the Official Inflation Story - 19th Apr 21
YuanPay Team Discuss The Process Of Crypto Diversification - 19th Apr 21
Central Banks May Ramp Up Gold Buying - 18th Apr 21
How to Get Rid of Driveway Weeds With Just WATER! 6 Months later NO Weeds, Ultimate Killer! - 18th Apr 21
State of the European Markets - DAX, FTSE, CAC, AEX, SMI, IBEX 35, S&P/MIB, Euro Stoxx 50, RTS - 18th Apr 21
Einvestment Fund: What You Need To Know About Investments - 18th Apr 21
Google Alphabet (GOOG) AI Deep Mind Stock Trend Analysis - 17th Apr 21
Stocks and Bonds Inflationary Slingshot - 17th Apr 21
Best Smartphone Selfie Stick Tripod Review by ATUMTEK Works with Samsung Galaxy and Iphone - 17th Apr 21
How to Give Budgie's First Bath | Easy Budgie Bathing and Water Training with Lettuce - 17th Apr 21
Record-breaking Decrease in New Passenger Vehicle Sale in Europe - 17th Apr 21
US Stocks Climb A “Wall Of Worry” To New Highs - 16th Apr 21
Gold’s Singular Role - 16th Apr 21
See what Anatomy of a Bursting Market Bubble looks like - 16th Apr 21
Many Stock Market Sectors Are Primed For Another Breakout Rally – Are You? - 16th Apr 21
What Skyrocketing US Home Prices Say About Inflation - 16th Apr 21
Still a Bullish Fever in Stocks? - 16th Apr 21
Trying to Buy Coinbase Stock on IPO Day - Institutional Investors Freeze out Retail Investors - 15th Apr 21
Stocks or Gold – Which Is in the Catbird Seat? - 15th Apr 21
Time For A Stock Market Melt-Up - 15th Apr 21
Stocks Bull Market Progression Now Shows Base Metal Strength - 15th Apr 21
AI Tech Stocks Buy Ratings, Levels and Valuations - 14th Apr 21
Easy 10% to 15% Overclock for 5600x, 5900x, 5950x Using AMD Ryzen Master Precision Boost Overdrive - 14th Apr 21
The Current Cannabis Sector Rally Is Pointing To Another Breakout - 14th Apr 21
U.S. Dollar Junk Bond Market The Easiest Money in History - 14th Apr 21
The SPY Is Nearing Resistance @ $410… What Is Next? - 14th Apr 21
The Curious Stock Market Staircase Rally - 14th Apr 21
Stocks are Heating Up - 14th Apr 21
Two Methods in Calculating For R&D Tax Credits - 14th Apr 21
Stock Market Minor Correction Due - 13th Apr 21
How to Feed Budgies Cucumbers - Best Vegetables Feeding for the First Time, Parakeet Care UK - 13th Apr 21
Biggest Inflation Threat in 40 Years Looms over Markets - 13th Apr 21
How to Get Rich with the Pareto Distribution - Tesco Example - 13th Apr 21
Litecoin and Bitcoin-Which Is Better? - 13th Apr 21
The Major Advantages Of Getting Your PhD Online - 12th Apr 21
Covid-19 Pandemic Current State for UK, US, Europe, Brazil Vaccinations vs Lockdown's Third Wave - 12th Apr 21
Why These Stock Market Indicators Should Grab Your Full Attention - 12th Apr 21
Rising Debt Means a Weaker US Dollar - 12th Apr 21
Another Gold Stocks Upleg - 12th Apr 21
AMD The ZEN Tech Stock - 12th Apr 21
Overclockers UK Build Quality - Why Glue Fan to CPU Heat sink Instead of Using Supplied Clips? - 12th Apr 21 -
What are the Key Capabilities You Should Look for in Fleet Management Software? - 12th Apr 21
What Is Bitcoin Gold? - 12th Apr 21
UK Covd-19 FREE Lateral Flow Self Testing Kits How Use for the First Time at Home - 10th Apr 21
NVIDIA Stock ARMED and Dangeorus! - 10th Apr 21
The History of Bitcoin Hard Forks - 10th Apr 21
Gold Mining Stocks: A House Built on Shaky Ground - 9th Apr 21
Stock Market On the Verge of a Pullback - 9th Apr 21
What Is Bitcoin Unlimited? - 9th Apr 21
Most Money Managers Gamble With Your Money - 9th Apr 21
Top 5 Evolving Trends For Mobile Casinos - 9th Apr 21
Top 5 AI Tech Stocks Investing 2021 Analysis - 8th Apr 21
Dow Stock Market Trend Forecast 2021 - Crash or Continuing Bull Run? - 8th Apr 21
Don’t Be Fooled by the Stock Market Rally - 8th Apr 21
Gold and Latin: Twin Pillars of Western Rejuvenation - 8th Apr 21
Stronger US Dollar Reacts To Global Market Concerns – Which ETFs Will Benefit? Part II - 8th Apr 21
You're invited: Spot the Next BIG Move in Oil, Gas, Energy ETFs - 8th Apr 21
Ladies and Gentlemen, Mr US Dollar is Back - 8th Apr 21
Stock Market New S&P 500 Highs or Metals Rising? - 8th Apr 21
Microsoft AI Azure Cloud Computing Driving Tech Giant Profits - 7th Apr 21
Amazon Tech Stock PRIMEDAY SALE- 7th Apr 21
The US has Metals Problem - Lithium, Graphite, Copper, Nickel Supplies - 7th Apr 21
Yes, the Fed Will Cover Biden’s $4 Trillion Deficit - 7th Apr 21
S&P 500 Fireworks and Gold Going Stronger - 7th Apr 21
Stock Market Perceived Vs. Actual Risks: The Key To Success - 7th Apr 21

Market Oracle FREE Newsletter

FIRST ACCESS to Nadeem Walayat’s Analysis and Trend Forecasts

How the Paper Fiat Money Experiment Will End

Currencies / Fiat Currency Dec 14, 2013 - 04:02 PM GMT

By: Philipp_Bagus

Currencies

A paper currency system contains the seeds of its own destruction. The temptation for the monopolist money producer to increase the money supply is almost irresistible. In such a system with a constantly increasing money supply and, as a consequence, constantly increasing prices, it does not make much sense to save in cash to purchase assets later. A better strategy, given this senario, is to go into debt to purchase assets and pay back the debts later with a devalued currency. Moreover, it makes sense to purchase assets that can later be pledged as collateral to obtain further bank loans. A paper money system leads to excessive debt.


This is especially true of players that can expect that they will be bailed out with newly produced money such as big businesses, banks, and the government.

We are now in a situation that looks like a dead end for the paper money system. After the last cycle, governments have bailed out malinvestments in the private sector and boosted their public welfare spending. Deficits and debts skyrocketed. Central banks printed money to buy public debts (or accept them as collateral in loans to the banking system) in unprecedented amounts. Interest rates were cut close to zero. Deficits remain large. No substantial real growth is in sight. At the same time banking systems and other financial players sit on large piles of public debt. A public default would immediately trigger the bankruptcy of the banking sector. Raising interest rates to more realistic levels or selling the assets purchased by the central bank would put into jeopardy the solvency of the banking sector, highly indebted companies, and the government. It looks like even the slowing down of money printing (now called “QE tapering”) could trigger a bankruptcy spiral. A drastic reduction of government spending and deficits does not seem very likely either, given the incentives for politicians in democracies.

So will money printing be a constant with interest rates close to zero until people lose their confidence in the paper currencies? Can the paper money system be maintained or will we necessarily get a hyperinflation sooner or later?

There are at least seven possibilities:

1. Inflate. Governments and central banks can simply proceed on the path of inflation and print all the money necessary to bail out the banking system, governments, and other over-indebted agents. This will further increase moral hazard. This option ultimately leads into hyperinflation, thereby eradicating debts. Debtors profit, savers lose. The paper wealth that people have saved over their life time will not be able to assure such a high standard of living as envisioned.

2. Default on Entitlements. Governments can improve their financial positions by simply not fulfilling their promises. Governments may, for instance, drastically cut public pensions, social security and unemployment benefits to eliminate deficits and pay down accumulated debts. Many entitlements, that people have planned upon, will prove to be worthless.

3. Repudiate Debt. Governments can also default outright on their debts. This leads to losses for banks and insurance companies that have invested the savings of their clients in government bonds. The people see the value of their mutual funds, investment funds, and insurance plummet thereby revealing the already-occurred losses. The default of the government could lead to the collapse of the banking system. The bankruptcy spiral of overindebted agents would be an economic Armageddon. Therefore, politicians until now have done everything to prevent this option from happening.

4. Financial Repression. Another way to get out of the debt trap is financial repression. Financial repression is a way of channeling more funds to the government thereby facilitating public debt liquidation. Financial repression may consist of legislation making investment alternatives less attractive or more directly in regulation inducing investors to buy government bonds. Together with real growth and spending cuts, financial repression may work to actually reduce government debt loads.

5. Pay Off Debt. The problem of overindebtedness can also be solved through fiscal measures. The idea is to eliminate debts of governments and recapitalize banks through taxation. By reducing overindebtedness, the need for the central bank to keep interest low and to continue printing money is alleviated. The currency could be put on a sounder base again. To achieve this purpose, the government expropriates wealth on a massive scale to pay back government debts. The government simply increases existing tax rates or may employ one-time confiscatory expropriations of wealth. It uses these receipts to pay down its debts and recapitalize banks. Indeed the IMF has recently proposed a one-time 10-percent wealth tax in Europe in order to reduce the high levels of public debts. Large scale cuts in spending could also be employed to pay off debts. After WWII, the US managed to reduce its debt-to-GDP ratio from 130 percent in 1946 to 80 percent in 1952. However, it seems unlikely that such a debt reduction through spending cuts could work again. This time the US does not stand at the end of a successful war. Government spending was cut in half from $118 billion in 1945 to $58 billion in 1947, mostly through cuts in military spending. Similar spending cuts today do not seem likely without leading to massive political resistance and bankruptcies of overindebted agents depending on government spending.

6. Currency Reform. There is the option of a full-fledged currency reform including a (partial) default on government debt. This option is also very attractive if one wants to eliminate overindebtedness without engaging in a strong price inflation. It is like pressing the reset button and continuing with a paper money regime. Such a reform worked in Germany after the WWII (after the last war financial repression was not an option) when the old paper money, the Reichsmark, was substituted by a new paper money, the Deutsche Mark. In this case, savers who hold large amounts of the old currency are heavily expropriated, but debt loads for many people will decline.

7. Bail-in. There could be a bail-in amounting to a half-way currency reform. In a bail-in, such as occurred in Cyprus, bank creditors (savers) are converted into bank shareholders. Bank debts decrease and equity increases. The money supply is reduced. A bail-in recapitalizes the banking system, and eliminates bad debts at the same time. Equity may increase so much, that a partial default on government bonds would not threaten the stability of the banking system. Savers will suffer losses. For instance, people that invested in life insurances that in turn bought bank liabilities or government bonds will assume losses. As a result the overindebtedness of banks and governments is reduced.

Any of the seven options, or combinations of two or more options, may lie ahead. In any case they will reveal the losses incurred in and end the wealth illusion. Basically, taxpayers, savers, or currency users are exploited to reduce debts and put the currency on a more stable basis. A one-time wealth tax, a currency reform or a bail-in are not very popular policy options as they make losses brutally apparent at once. The first option of inflation is much more popular with governments as it hides the costs of the bail out of overindebted agents. However, there is the danger that the inflation at some point gets out of control. And the monopolist money producer does not want to spoil his privilege by a monetary meltdown. Before it gets to the point of a runaway inflation, governments will increasingly ponder the other options as these alternatives could enable a reset of the system.

Philipp Bagus is an associate professor at Universidad Rey Juan Carlos. He is the author of The Tragedy of the Euro. See his website. Send him mail. See Philipp Bagus's article archives.

© 2013 Copyright Philipp Bagus - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules