Money Sage

We now have solid confirmation that the financial implosion of Europe is now in train. While some miracle may yet occur, odds are heavy in favor of the de facto collapse of the banking and financial systems of Europe, attended for the first time by sovereign debt defaults. Clearly, the global financial crisis has now reached a new, and unprecedented, level of severity.

The issue, it seems to us, is that what we have long expected is now occurring in Europe, even as frightening if currently much weaker indications of the same inevitable phenomenon manifest themselves here. In short, what we are witness to is the decisive defeat of the central banks in their effort to print their way out of the debt quicksand in which they have trapped themselves. The BOND MARKET IS
STRONGER than the central banks and government combined -- much stronger. As we have suggested for the past two years, the credit market has the ability to force central banks to choose between the Scylla of deflationary depression and hyperinflation, itself a prelude to depression. The NECESSARY CONDITION for central bank/government reflationary efforts in the face of the crushing debt overhang REQUIRES the passive acquiescence of government creditors in their own financial decimation. Governments and central banks have counted on their ability (or have given rein to the wishful thinking necessary to proceed)to hypnotize, narcotize, and sweet talk investors in government bonds into believing that all will be well if only they go along with central bank money-printing. After all, central banks can be trusted to call a halt and reverse the process once the financial markets "stabilize," and economic recovery develops. Of course, there is no inflationary or debasement consequence as long as freshly minted money, created by the magic strokes of the central banks' computers, is not successfully injected into the real economy. In fact, this has continued to be the case -- the banks will not lend, and borrowers will not borrow.

However, bondholders are frightened, and growing more so by the day. They are frightened that the central banks' money-printing MAY ACTUALLY WORK. The very possibility of such a success can only come at the cost of the true value of the creditors' bonds. Unfortunately for the central banks and governments, BONDHOLDERS ARE WELL AWARE OF THIS FACT. Consequently, they act to PREEMPT such financial damage to themselves, and they do so BY SELLING THEIR GOVERNMENT BONDS. This drives market rates much higher, and prices much lower, panicking other bond investors into selling. The only way to counter this is for the central banks to ACCELERATE THEIR MONEY-PRINTING,

And what, precisely, do the central bankers THINK that bondholders will do as that occurs? Even a moron would realize that they will sell more and more rapidly. So, the central bankers CANNOT generate a "moderate" inflation -- ie, de facto limited though insidiously growing de facto confiscation of creditor wealth and income, for the benefit of the debtors, largest of whom are governments of course. The bond market can act MUCH FASTER than the central bank can print money. This is the decisive reality neither Bernanke, nor Milton Friedmann, nor any of the distinguished economists have yet figured out. Or, have chosen to ignore, actualizing the principle that "there are none so blind as those who will not see."

The bottom line, we think, is that the central banks, and the governments they serve, are CHECKMATED. Inflation-phobes need not worry: even a hint of accelerating money-printing has produced precisely the sell-off in government securities which central banks and governments fear above all else.

The bottom line, as we see it, is that the inflation-phobes are barking up the wrong tree. The pathetic inflation-generating efforts of the FED will merely move much closer the deflationary panic and economic deterioration which lies ahead.

Once again we must ruefully conclude: with central banks, we do not need enemies.

moneysage, November 2010