Japan leads the way...through a minefield
By
Bill Bonner Jan 28, 2010
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Science and technology have produced many wondrous breakthroughs. But there are some things it cannot improve. A kiss from natural lips is still the lover’s choice. Baby formula proved no match for the real thing. Ersatz money is a flop too.
That last item is not so much a fact as a prediction. The first modern competition between gold and paper money ended like the pre-modern ones. Gold won. Herewith, a short summary. A rogue, John Law, was the protagonist of the story. He killed Beau Wilson in a duel. Then, he went on the lam... first to Scotland... then to Amsterdam... and finally to Paris. Like Alan Greenspan or Ben Bernanke, he made himself useful to people in high places – in this case, the Duke d’Orleans, who needed money.
Law had it: “I have discovered the secret of the philosophers’ stone”, he is said to have remarked. “It is to make gold out of paper.” We need look no further. Law may have been good with figures; it was at philosophy that he failed. A thing cannot be both one thing and another thing at the same time. It is either gold. Or it is paper. Rarity and durability give gold value – as money. Paper’s most conspicuous properties are just the opposite – it is common, and has a tendency to curl up and blow away.
Law’s new, easy money helped France to an economic recovery – or so it seemed. But in the end, the philosophical error caught up with him. Gold has real value. If you can create it at will, why not create more of it? It was just a matter of time before he had created too much. Soon, there was an angry mob outside Law’s office on the Rue Quincampoix. The people who held his paper gold had come to see it in a different light. Where once they admired it, now they despised it.
Law’s scheme increased the money supply – including banknotes and shares in his Mississippi company – by 300%, before the crisis began. Prices in Paris doubled between 1718 and 1720. Then, under pressure, the Duke d’Orleans “cranked up the printing press”. By 1721, Law’s money was worthless. “Banque” was a dirty word in France for the next 200 years.
The current experiment with paper money began on 15 August 1971. Henceforth, said Richard Nixon, foreign countries that wished to exercise their right to trade US dollars for gold could go fish. From that point forward, the dollar was worth only what someone would give you for it. Philosophers held their breath. But nothing happened. Many have died since, waiting for the dollar to succumb first. Still, the millstones of monetary history may grind slowly, but the more slowly they grind, the more fingers they pinch.
The new paper money standard allowed for a worldwide credit boom – just as in Paris following the establishment of Law’s scheme. The US created dollars. Its citizens spent them. The dollars accumulated as reserves all over the world... and every central bank raced to keep up. Soon, the exporters were producing too much. The importers were consuming too much. And there was too much money and credit everywhere.
The Japanese economy was the first to blow up – in 1989. The government tried to revive the boom by lowering interest rates. The Japanese were numb. But the rest of the world borrowed... and boomed even more. After the tech bubble blew up on Wall Street, the Americans provided the stimulus. Wall Street and the City flourished. China worked overtime. Then, in 2007, the planet-wide bubble popped. Suddenly, the whole world was Japan.
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And now, every nation in Christendom, to say nothing of the others, is following Law’s example. All are running huge, counter-cyclical deficits – issuing paper gold – in the form of bills, notes, and bonds – as if they were the Banque Royale. Europe is estimated to need $2.2trn in deficit funding this year. The US will need at least a trillion more. If the depression deepens, maybe $2trn. How long can this go on? Where will it lead? Where will they get the money?
“There are no means of avoiding the final collapse of a boom brought about by credit expansion,” wrote Ludwig von Mises. “The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” The world has chosen later. But later may not be too far away. On Tuesday, the S&P rating agency issued a warning. If Japan continues in the direction it is going, it would have Hell to pay. Japan leads the way – across a minefield. And her feet grow larger. She borrows more and more as her own people grow older and save less. Already, for every dollar she receives in tax revenue she borrows $1.20 cents more. She is sure to make a mis-step soon.
No natural life survives the lifecycle. And no paper currency, not backed by something real – notably gold – has ever survived a complete credit cycle. Since 1971, the dollar credit cycle has been in expansion. Now it is in contraction. Listen for the sound of an explosion and wait to see body parts flying.
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