There are four stages of fiat money printing that have been used by central
banks throughout their horrific history of usurping the market-based value
of money and borrowing costs. It is a destructive path that began with going
off the gold standard and historically ends in hyperinflation and economic
chaos.
Stage one is the most benign of the four, but it sets the stage for the baneful
effects of the remaining three. The first level of monetary credit creation
uses the central banks' artificial savings to set short-term interest rates
through the buying and selling of short-duration government debt. This stage
appears innocuous to most at first but is insidiously destructive because it
prevents the market from determining the cost of money. This is crucially important
because all assets are priced off of the so called "risk-free" rate of return.
A gold standard keeps the monetary base from rising more than a few percentage
points per annum and thus restrains bank lending. However, having a fiat currency
also means a nation has a fiat monetary base. This leads to unfettered bank
lending and the creation of asset bubbles.
The second stage of monetary madness has been around for decades but is now
commonly known as Quantitative Easing (QE). After several cycles of lower and
lower short-term interest rates that are intended to bring the economy out
of successive recessions, the central bank (CB) ends up pegging rates at zero
percent or below. Once CBs run out of room on the downside of short-term rates
they go out along the yield curve and begin to artificially push down borrowing
costs for long-term debt. It is important to note that at this stage CBs only
purchase assets on private banks' balance sheets and at least pretend they
will someday liquidate these holdings.
The third level of monetary madness is now being threatened to be imposed
upon the population by central banks across the globe. This stage is called "Helicopter
Money" and is the brainchild of noted economist Milton Friedman. But in reality,
versions of it have been used many times prior to Mr. Friedman's appellation
of central bank money drops. Friedman argued the use of Helicopter Money to
combat deflation, but it has been traditionally used to help an insolvent government
service its debt.
At its core, Helicopter Money is defined to be the issuance of non-maturing
government debt or the direct issuance of credit to the public that is financed
by the central bank. Both forms of money drops operate most efficiently by
circumventing the private banking system. This is because CBs and governments
don't have to worry about private banks deciding to forgo buying more government
debt if favor of holding the fiat credit as excess reserves. Helicopter Money
allows citizens the direct access to new credit without the threat of having
it unwound from the CB. The main difference between non-maturing debt issuance
and direct public credit is the former allows the government to direct who
gets the new money, and the latter gives the CB that discretion. But in either
case, Helicopter Money amounts to a direct increase in the broad money supply
and inflation.
As I mentioned in last week's
commentary, The Bank of Japan and perhaps even The European Central Bank
are seriously contemplating saying "get to the chopper" very soon. Alas,
once you get to level 3 there will be an inexorable march towards the next
level. This is because there is no calling in the helicopters without causing
a devastating plunge in asset prices and a bond market collapse, which results
in massive economic chaos.
This brings us to the final stage of central bank intervention, which is the
interminable and direct purchase of sovereign debt by a central bank for the
sole purpose of keeping interest rates from spiraling out of control. Hence,
the 4th stage of Monetary Madness occurs once inflation becomes fully entrenched
in the economy.
It would be pure folly to assume that central banks can achieve their 2% inflation
targets with impeccable precision. Years' worth of deficit spending, surging
debt to GDP ratios and a gargantuan increase in central banks' balance sheets
will eventually lead to a significant erosion in the confidence of central
bankers to maintain the purchasing power of fiat money. Therefore, inflation
won't just magically stop at 2%; it will eclipse that level and continue to
rise.
But that's only half of the issue. Sovereign bond yields have been slammed
so far down by CBs that nearly 30% of the entire supply of government-issued
debt now trades below zero percent. The return of inflation must surely cause
a mass exodus of longs from the bond market, just as short sellers begin to
pile on top. The bond market will also respond in violent fashion -- taking
yields up 100's of basis points rather quickly -- due to the anticipation of
waning bond bids from central bankers.
Of course, surging debt service payments will render debt-saturated governments
completely insolvent, which forces central banks into stage 4. Sadly, this
is the conclusion that lies ahead for the developed world. Investors should
not become complacent with the current innocuous state of global bond yields.
In reality, they have become incendiary bombs that will inevitably explode
with baneful implications for those that are not fully prepared.
