Money Sage

The de facto insolvency of the sovereign state Dubai brings to the fore a question of profound gravity. This question is universally unstated, ignored, and denied when on rare occasions it is raised.

We have, from the outset of the financial crisis in the summer/fall of 2007, noted the vast deflationary probabilities likely to be unleashed in a world at the apogee of over-indebtedness, over-leveraging, over-speculation, de-regulation, de facto bank autonomy from snoozing regulators, AS WELL AS the vast global overcapacity of many key industries -- steel, autos, retail, airlines, etc. In a "normal" world the ultimate upshot would have been deflation and depression, on a pretty much global scale.

This has not happened, YET. And mercifully so. Those who facilitated, ignored, and rendered possible the Frankensteinian global bubble in real estate, finance, and industrial and distribution overcapacity have "rescued" the world via the simple expedient of debasing fiat money, thereby resuscitating numerous key enterprises from their near-death experience, and preventing a classic financial panic from developing into a major depression.

Of course, this provisional "rescue" from the abnormal situation the central banks and major governments created has its costs. That these costs are only now beginning to become visible is no indicator of what their full extent may prove to be, or the intensity and pervasiveness of the financial and economic pain they may in due course produce.

Leaving aside the specific implications, let us suffice to note the following:

1. The furious money-printing has effectuated a multiplication of "hot money" and distortive speculative flows, producing stock and real estate bubbles in certain important Asian countries;

2. These bubbles may have a far way to go before they burst, but burst they will. They always do;

3.One must wonder, as an aside, what governments and central banks will do after the next burst, which we can reasonably assume will be considerably worse than its predecessor;

4. Money creation en masse, designed to prevent the normal workings of a capitalist system, have the effect of having an impact on financial markets greater, by orders of magnitude, than their impact on the economy. In other words, a mountain of freshly printed money will move markets to stratospheric levels, while the economy merely inches along.

5. Essentially, the money-printing machine and related central bank and government financial guarantees and abnormally large and low quality asset purchases have accomplished several things:
(a)They have effectuated the transfer of wealth from creditors to debtors (of whom governments constitute a major sector);
(b)They have moved us closer to the ultimate Scylla and Charbydis, whose existence they, and the politicians, they have persistently denied: i.e., the central banks' choice is narrowing to a choice between depression and hyper-inflation. In point of fact, hyper-inflation may prove but a transient phase before depression sets in. This depression may have either a hyper-inflationary coloration, or may be an out and out deflation.
(3)They gave purchased temporary stabilization for a terrible future price, the shape of which is currently far from clear.
(4)They have seemingly validated the most ruinous of all financial and economic myths: the myth of the free lunch. The payback for this will come, sure as the sun rises in the morning and sets in the evening.
(5)A large part of the crushing debt burden incurred by banks and major corporate enterprises has been assumed by governments

The Dubai de facto insolvency raises the obvious point: how many other insolvent, or near-insolvent, governments are there?

What would the impact of MULTIPLE STATE INSOLVENCIES
be?

How much paper "money" must major central banks print, how much debt must they sell?

How much government-issued debt must they sell TO THEMSELVES? (in the case of Britain, for example, the central bank has already purchased a reported ONE-THIRD of all outstanding government bonds). This, of course, is the same thing as printing money.

Will we witness a panic over government paper, the way we saw a panic in private sector bonds a year ago? If so, who will bail governments out, MARS??

Markets, as Keynes noted, can be irrational for a lot longer than rational investors can remain solvent. Ergo the shibboleths: don't fight the FED, don't fight the tape. Problem is, no one knows when rationality will emerge. The longer we put off taking our medecine, the more awful the medecine will likely be, and the more egregiously painful and ruinous the patient's "recovery."

Moneysage 2009 - copyright