Bill Bonner: an avalanche of claptrap
By
Bill Bonner May 22, 2009
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Like snow at high altitudes, the central banks' new money is piling up. As reported last week, all the world's major central banks have turned on their snow machines.
The US Federal Reserve has been authorised to 'print' $1.75trn worth of new money to buy Treasury bonds. The Bank of England has its own programme – worth £75bn, so far. Even Switzerland has been printing money – so much that its money supply, as measured by M-2, is growing at 30% a year. And two weeks ago, the European Central Bank announced it too would begin creating money to buy corporate bonds.
'Quantitative easing' (QE) it is called. As a refresher for readers with real lives and better things to do, QE is how central banks describe what is essentially an act of counterfeiting. They buy bonds with money created – electronically – specifically for that purpose.
Abracadabra! – 'money' comes into being. The feds aim to provide liquidity for the cities and farms. But so far, only a trickle is coming down. Instead, chilly weather in the upper reaches of the financial sector holds it frozen in place. Hundreds of billions comes down from central banks, but there it stays, waiting for spring.
Today, here on the back page, we ask ourselves a simple question: what will happen to it? The feds' counterfeit money does such a good imitation of the real thing, you can't tell them apart. But the problem with all money is that it is fickle and unreliable.
According to theory, an increase in the supply of something leads directly to a decrease in the price of it – that is, if other things remain constant. Despite the credit crunch, the banking freeze-up, and the economic recession, the money supply in the US as measured by M-1 is actually rising at 14% per year. Yet consumer prices are not keeping pace. The latest report shows them actually going down slightly over the last 60 days.
It turns out that causing inflation is not as easy as it looked; controlling it probably will be even harder. It's not enough to manage the quantity of money; you also need to be able to control its behaviour. Money is either a solid, a liquid, or a gas, depending upon the temperature of the economy.
At normal temperatures, money runs freely, watering the economy. When things really get hot, it vaporises, creating gaseous bubbles such as those of the late Bubble Period. But when the temperature falls, money shivers in wallets and bank accounts – reluctant to go out into the cold – or fills up mountain passes, until warmer weather comes. Economists refer to the 'velocity of money' to describe the magnifying effects of motion. When the same dollar bill appears in three different places in the same day, it is as if the money supply had been multiplied three-fold. In a freeze, on the other hand, it comes to a dead stop.
When the thaw will come, we don't know. But the authorities are ready for it. When consumer prices begin to rise, they'll stop adding to the money supply. Then, they'll withdraw liquidity, as needs be, to keep it under control. They know that runaway inflation would cause problems – the collapse of the dollar and the US Treasury bond market, for example. So, at the first signs of inflation, they will move quickly to remove excess liquidity from the system. How? Their emergency plan is simple enough. Now, they are buying bonds. When their inflation targets are met, they will begin selling them.
We thought the Bubble Epoch was the peak in claptrap and illusions. But we were only in the foothills. The feds now pretend to bail out the economy by giving money to companies that pretend to be going concerns run by people who pretend to know what they are doing. And when they run short of money, they create more of it, pretend it is real – and pretend they can tell it what to do.
What is likely is that money will have a mind of its own. First, the markets will react – and the authorities will not. They will remember their own critiques of Japanese and Roosevelt-era monetary policy. In both cases, they believe central banks removed the punch bowl too early – before the party really got rolling. In both cases, the recovery was cut off.
Then, while they are hesitating, money will turn on them. Inflation rates will rise further. The velocity of money will pick up. And investors – including foreign governments – will become eager sellers of US Treasury debt. Suddenly, it will be too late. In order to remove the monetary inflation they previously added, central banks will have to sell bonds instead of buying them, trying to re-absorb money from the economy. The extra cash would then vanish back into the central banks.
But in order to bring inflation under control, the biggest bond buyers in the world must turn into the world's biggest sellers. Bond prices, already falling as investors feared the worst, will collapse immediately. An avalanche of dollars will fall upon the world markets – as dollar holders all over the world become desperate to get rid of them.
We don't know what day it will happen. But we have a good idea as to what time of day. About 4am is our guess. That is the moment when Ben Bernanke and other central bankers will realise they have stranded themselves on the mountain – and are about to be buried.
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