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Is
the Debt Crisis really over?
The
fundamental Analysis Bankers
don’t disclose
The credit
mania leading to the present
crisis is a school model of malinvestment resulting from run away
credit expansion, pep talk and grossly underrated inflation and credit
risks. The European
central bank (ECB) played a central role in the credit mania. For
the sake of the lagging countries in the European Monetary Union the
ECB kept interest rates too low for too long, causing run
away money supply in Europe still adding to the worldwide credit
bubble initiated by the FED.
Is the risk
of a full blown recession foreclosed or is there more financial turmoil
coming ? We investigate whether the deeper causes leading to the
debt crisis and housing bubble are being remedied.
1.
Runaway
Money Printing in Europe and the US.
At the
launch of the Euro the founding
nations agreed a double a
monetary
objective to guarantee
financial stability of the EMU: an inflation target of 2%, and a growth
rate of the total
money
supply (M3) of approximately 4.5%. Scientific
research indeed proved
that the
money supply rate provides an excellent forecast for the inflation rate
some
three years later, and that restricting the money supply to 4.5% limits
future
inflation to 2%.
Over
the
first eight years the average money supply in the Euro area in reality
reached
6.9% or more than half above the target. Eight years after its
founding, the
latest ECB money growth rate reached a provisional peak of 11.7%, or
roughly
10% above the growth rate of the real economy.
(see
2).
In every day words this means that for
the moment an 11.7%
larger
amount of money is chasing a quantity goods and services that is hardly
1.7% larger than twelve months ago. The consequent inflationary
pressures on prices can be guessed even without econometric models.
The
11.7% figure is the latest
available rate for July. That is the
month preceding the hedge funds crisis, and before the ECB decided to
inject massive liquidities into the financial system in an effort to
keep the acute liquidity shortage under control. This new injection
will have steeply accelerated the money supply and will most probably
bring the August
rate close to 14% thereby equalling the FED's
money growth rate,
which just reached its fastest rate in
35-years. (see here or here
) 14% is also
about three
times the
agreed and
repeatedly confirmed target of 4.5%, and an acceleration of the
exponential trend initiated since Trichet's was nominated as president.
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Very
remarkably and against all
economic logic major price hikes have not
materialised so far. However not without raising doubts over the
representativeness of the ECB’s inflation rate. The figure of about 2%.
is indeed believed to systematically and grossly underestimate real
price hikes.
Keeping
the
Consumer Price Index (CPI) representative for the actual cost of living
has
always been a point of dispute in Europe. Authorities always
found indeed good
reasons to simply
strike the fastest rising items such as oil or cigarettes and most
importantly taxes from the CPI list just as if these were
unimportant
details in the family budget. |
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2.
Grossly underestimated
inflation threat
This still adds to the ECB’s impossible
task of weighing rising shares of services in family budgets of
differentially aging populations, and makes the weighing of changing
consumption patterns in very different economies even more awkward. In
fact the ECB inflation rate is a highly obscure average of most dissimilar
inflation rates of still very disparate EMU economies, and as an
average it is by definition concealing much larger inflation rates in
some of the major countries.
More importantly the ECB’s inflation rate does also rather
systematically underestimate real inflation because it does not ponder
the lowering
quality of goods as it compares today’s low quality import stuff
with the top quality domestic produce Europeans were used to a few
years ago.
However the most weighty criticism on the
ECB’s Consumer Price Index (CPI) is that by definition it covers consumption items only,
and that the rapidly rising house prices (and asset
prices in general) are unaccounted for. The resulting
underestimation is most important as the monthly mortgage payments for
an average family dwelling now account for one third of the European
family budget.
Inflationary pressures have also been delayed by the increasing
use in industry of futures and option contracts to cover
future raw material needs. All these financial constructions
have indeed the common feature of creating a virtual offer (of raw
materials) that in reality does not (yet) exist and whose effective
delivery is secured by non existent material. Guarantees often are
supplied by dubious market participants not seldom operating from some
obscure attic. This virtual offer has long kept prices low,
dissimulating the looming shortage of foodstuffs, metals and energy.
These constructions have temporarily retarded inflation but certainly
did not eradicate it in the long run.
3.
Redundant M3
target ?
In spite of the obvious underestimation
of the inflation threat, the bank sector has seized the ECB’s
suspiciously low CPI to dispute the value of the M3 money supply
target. In a recent analysis (see 3) the generally well respected Goldman Sachs research
department asks the question most
openly why the bank sector should be
limited by M3 targets as inflation remains low anyway. Why not allow the sector to
print money as much they feel necessary, and yes, why not accelerating
the printing machines? The economy mosr probably even would benefit some
Keynesian economist continue to make us believe even today. Even top
economist and once Belgian candidate for the ECB presidency
Prof. De Grauwe, has questioned the value of
the M3 target. (see 4)
The old universal relation between prices and money supply obviously is under
serious attack in banking circles. As a matter of fact the ECB
has despite all its solemn declarations in practice not worried in the
least about the money supply. For deciding its interest policy, the ECB
has ignored M3 just as much as the FED always did.
4. Virtual
Alchemy makes Banks rich
....and Citizens poor
The banking sector obviously has
very good reasons to have money supply target abolished. After
all their virtual alchemy turning paper into gold or at least into real
purchasing power is a most lucrative business.
For the productive
citizen however the results of an abolition of the M3 target would be
devastating as all the purchasing power the banking sector acquire by
means of printing money is purchasing power which is diluted from the
people's buying power they have worked so hard for.
Therefore If there is
anything citizens must by all means fight to conserve, it is the money
supply target. In the present  monetary system without
any gold backing
it is the only remaining restraint against wild money printing. Even
though the ECB’s present target of 4.5% is unarguable much too high, it
is our only guarantee against a progressive erosion of our buying
power.
As long as the
gold-backed money standard is not restored only a
money supply target near to the growth rhythm of the real economy can
indeed prevent inflation and allow purchase power to keep up with
productivity. Any growth rate above this rhythm is inflationary in the
true sense and is endangering the economy...
”The
substitution of paper money for metallic currency
is
a
national gain: any further increase of paper
beyond
this is but a form of robbery ...
all
holders of currency lose, by the
depreciation of its value,
the
exact equivalent of what the issuer gains.”
John
Stuart Mill
No, it is not the money supply rate which is flawed, it is the
inflation target which is a conceptual economical inconsistency. The
detrimental consequence of targeting inflation (at an excessive rate of
2%) is that the average price level can no longer decline. As a result
the price mechanism is incapacitated, and the self healing effect of
price reductions during economic downturns
is lost. Prices can also no
longer ease in times of exceptional productivity gains such as we enjoy
today.
5. Counterfeiting.
Since over a decade our economy benefits
from a most exceptional period of progress. Globalisation has boosted
productivity as it allowed the abolition of trade barriers,
liberalisation, privatisations and increasing mass production.
Technical innovations have also strongly improved products as well as
production processes. Robots, Internet, GPS, mobile communication,
digitalisation, bio- and nanotechnology are only a few of the latest
innovations.
Tanks to this exceptional period of both technological innovation and
economic progress we now pay only half the price we paid 20 years ago
for products like electric and household equipment, textiles, or
picture prints down even to 10% only for items such as computers,
mobiles, printers and air travel. Very remarkably the average price
level continued tot rise in spite of those massive price reductions.
The reason is that the inflation target prevents the average price
level from falling and people’s buying power from rising. Inflation
targeting indeed prevents increased productivity benefiting the average
consumer. Targeting
inflation at 2% in practice means nothing less than institutionalised
confiscation of all future prosperity gains resulting from progress.
 By targeting a 2% inflation the Central
Banks do indeed set its interest rates accordingly low, stirring
expansion of credit and money supply and thereby diddling bit by bit
and almost unnoticeably hard-earned purchasing power from the
productive citizens. By lending purchasing power which is nowhere
borrowed the bank sector does indeed bring unearned money into
circulation against which no production of goods and services were
produced in the real economy.
As huge quantities of such unearned money are in circulation without
finding new goods and services to buy in the real economy, the
excessive money cannot but find a spending outlet in the available
stock of consumer goods and investment opportunities. The excessive
money supply has therefore the same inflationary impact as
counterfeiting as the new money dilutes a fraction of the purchasing
power of money people own.
6.Real
Estate Bubble.
 This brings us to the second detrimental
consequence of the excess money supply, namely that Europe is heading
straight on a real estate bubble just like the US did before us. As
real estate was widely believed to be the best investment in an
inflationary environment, demand for real estate has exceeded supply
for over a
decade.
As a result European house prices have
soared much more rapidly than
salaries, not seldom at rates of over 15% per year. With the help of
the easy credit; inflationary low interest rates and the extended
mortgage pay back period up to 40 years, monthly mortgage payments for
a property dwelling were kept artificially low and seem close even to
rent prices. Certainly so for the inexpert newcomers on the home market
who often naïvely discount never ending price hikes and forever
lasting low interest rates in their calculations.
In a vicious circle the easy credit,
inflation and undersized down payments have boosted demand for houses
resulting in the present exorbitant price level Europe knows today.
Measured to purchasing power it is now close to 30% (up to 50% even in
rural areas) above the American level, which started its implosion
already a year ago. Despite
massive productivity gains in the construction sector, the purchase of
a family dwelling now condemns both family partners to the stingy
existence  of thirty or forty years debt-forced-labour where previous
generations easily acquired their family dwelling with one single
salary only.
The European housing bubble also cannot but turn into financial
calamity sooner or later. The slightest tightening of the credit
market, increase of unemployment or interest rates may cause a
domino-effect, beginning with the last buyers, who purchased at the
highest level. Many of them have obligations at the limit of their pay
back capacity, live just one paycheque away from insolvency or have
chosen the risky mortgage with variable interest rates their bankers
their bankers so convincingly advised. These will be the first to face
foreclosure in a bear market where potential buyers may chose to await
further price falls...
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7. Savings shortage.
The worst consequence however of an easy
money policy is that inflationary low interest rates discourage saving.
In most of Europe the net real interest after costs, taxes and real
inflation have now been close to zero or even negative for several
years. In the industrial world household savings consequently declined
and fell to historical low of 5% of GDP down from 12% a decade ago (see 5). Such extreme low saving rates have the
factual outcome of citizens now entirely rolling off the costs of the
demographic ageing and the pension charges to their children.
8. Overconsumption
and mal-investment.
In the week following the heat of the hedge fund crisis the Belgian
National Bank authorities positively welcomed a new low of the savings
rate a sign of increased consumer confidence. Such cynic
hoorah-messages totally lack responsibility and still amplifies the
perilous illusion of wealth the easy credit generates. Such politically
inspired pep talk as well as banker’s get-rich-quick stories and easy
credit all generate an overoptimistic climate and hide the instability
of the monetary system central banks got us into. It all helps to
generate overoptimistic investment expectations and over-consumption.
As long as borrowed money is used to finance productive investment,
the income generated by such investment is usually satisfactory to
finance repayment.
Not so when easy credit is spent on luxuriously consumption. Ever
larger cars, boats, holiday villas, Champagne parties, holiday travel,
costly spectacles and sport events are so typical for a bubble economy
just before the burst…
Neither so when easy credit, -not based on real wages, rents and
dividends, but on overoptimistic virtual price hikes of stock and real
estate- is invested in speculative manias. As happened so many times
before in history, from the tulpomania to the internet bubble, it was
again over optimism and easy money generating the present real estate
madness and which grossly disturbed risk pricing of the treacherous
American CDO’s (see
6).
Moreover,
easy credit creates an illusion of wealth that indirectly also affects
the productive investor. Scarce capital will be misdirected to provide
for a demand that is bound to collapse when the overconfident consumer
suddenly realizes prices of more urgent and basic products soar.
9.
Over-indebtedness:
Recipe for monetary Crisis.
Easy credit
unavoidably
ends in a depression, because even cheap credit sooner or later must be
paid back. When the end is nearing of a long period of
inflation, overoptimistic expectations drive citizens to the limit of
their debt service and debt refund capacity. That is when time is ripe
for the burst. On the
slightest tightening of credit conditions, economic slowdown or rise of
unemployment, those debtors cannot but fail on their monthly payments.
Over indebted consumers are obviously most vulnerable as their
transient consumption obviously cannot be undone or marketed against
cash.
 But industrialists also
are blinded by easy money as low interest
rates cause overoptimistic
profit expectations especially in the most indebted and most vulnerable
companies. During such an inflationary boom production of
capital goods can hardly keep up with easy credit. New machines and
factories cannot be delivered fast enough and in an ever accelerating
rate managers typically take over other companies at ever higher prices
and ever lower returns. Also the liquidity of such high priced and low
-productive investments, which during the boom seems inexhaustible, can
dry up instantly when the economic prospects turns for the worse or
interest rates sooner or later start to rise. Pricey take overs and
marginal investments then suddenly become
impossible to sell, so that
in a chain reaction massive foreclosures and bankruptcies’ occur.
US debt service reaches historical highs
source : http://www.federalreserve.gov/releases/housedebt/
Excessive credit expansion does indeed at the very start carry the germ
of a financial crisis. Depressions should not
be mistaken as minor
incidents from a distant past. The latest major Japanese financial
crisis is scarcely twenty years old and reduced the Japanese stock and
property prices down to one quarter..
10. Crash
foreclosed… temporarily ?
Few seem to realise the instability of our present financial situation,
and how close the
excessive money supply brought us to the collapse the monetary house of
cards central banks created.
The announcement on august 9th of the renowned French bank BNP that
they had to suspend the operations of three of their leverage funds
abruptly shocked the faith in the whole European bank system. A few
days earlier German banks already had to intervene to save IKB Deutsche
Industry Bank and two leverage funds of mortgage specialist Bear
Stearns went bust. Suddenly everyone distrusted everyone, and nobody
dared to grant credit to nobody. In just a few hours the liquidities on
the European money market dried up completely. If central banks had not
intervened with a massive injection of liquidities at an interest far
below the market rate, many banks would impossibly have found the
liquidities they needed and would have failed. Even the largest banks
face losses for billions on the derivatives based on irretrievable debt.
Observers feel that the ECB’s liquidity
injection sends the wrong message to financial markets that she is
prepared to rush for aid even to the most reckless speculators. This
obviously is not the kind of message which will deter hedge funds and
speculators from engaging in further debt and even larger risks. This
way the disequilibrium continues to exist and even to worsen, and the
indispensable ' creative destruction ' of speculative excesses does not
materialise.
Hedge funds have used derivatives, financial engineering and
uncontrollable levers to engage in exorbitantly bully exposure. They
inflated markets with their speculation. With deceiving -of balance
sheet- constructions they involved ignorant investors in their
adventures. As long as all went well they cashed huge profits for their
funds as well as their administrators. Now that it turns for the worst
central banks must not rush to the speculators’ aid a second time with
even more inflationary interventions. Investors and financial
institutions must carry the consequences of their reckless greediness
themselves.
Epilog
: Game over
The massive ECB
liquidity injection only postponed the unavoidable and larger
corrections still to come. The cash injection has not restored any of
the fundamental imbalances, nor provided strength to the
inflationary house of cards central banks have created. The real estate
market remains overpriced and just as inaccessible for hardworking
families as before. Millions American houses still have not found a
ready buyer. Interest rates and savings rates remain much too low to
finance demographic ageing. Europe’s social model is still heading
with the same speed for an Argentinean style debt crisis.
The remedial effects of the ECB’s liquidity injections will indeed be
short lived, as new acute liquidity shortages are in the pipeline when
ever more irretrievable debts reach maturity and foreclosures
also
reach European markets. New liquidity injections would engage in the
deadlocked path of an ever accelerating money supply and
hyperinflation. The longer Central Banks postpone the unavoidable
correction and continues their feast of diluting peoples buying power
with inflationary low interest rates, the deeper the final crisis will
become all the larger and the detrimental effect on our prosperity. It
is not for Central banks to save reckless speculators with ever more
inflation at the expense of hardworking citizens, nor disturb the
correct pricing of risk, nor to intervene at the smallest correction.
Mild corrections are beneficial because they clear out speculative
excesses and could maybe still help to avoid a 1929 like depression.
In the coming weeks and
months savers should be advised to closely monitor money growth rates
of the ECB and the FED. As usual, Central
Bankers will probably try fighting the fire with more fire and attempt
to combat
the present problems with inflated asset prises with more inflationary
measures.
Any acceleration of the money supply rate would be the
unmistakable early warning of a heavy inflationary period coming, and a
clear signal for protective action.
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Is
on-line banking Safe ?
Lessons from the Northern Rock Bank Run
"Northern Rock", once a star of British banking and one of the largest
mortgage lenders applied for emergency aid from the Bank of England to
prevent a bank run. Instead, it precipitated one.
In
the course
of a single weekend, before the government guaranteed Northern Rock's
deposits and police turned away panicky customers, the bank lost some
$4 billion as
customers emptied their accounts.
As the Economist magazine notes, this
was
England’s first bank run since 1866.
The fact that customers also failed to access their on-line bank
accounts, causes widespread doubts
about the reliablility of the
online banking system in case of a
major crisis and raises questions also about
the poor liquidity of deposits on on-line bank accounts.
More
Youtubes on Northern Rock here
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Very Recommended
Background information :
by
Christopher Laird PrudentSquirrel.com Feb 22, 2007
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Very Recommended
Reading :
 From both an
economic and monetary perspective, the United States is a house of
cards—impressive on the outside, but a disaster
waiting to happen
beneath the surface. In a relatively short period of time, the country
has gone from the world's largest creditor to its greatest debtor; the
value of the dollar has declined; and domestic manufacturing has given
way to non-exportable services. While these and other issues could
potentially spell disaster for your financial well-being, the situation
could also present unique opportunities—if you're prepared. Now, in Crash Proof, Schiff
provides you with an insightful examination of the structural
weaknesses underlying this impending economic meltdown, and discusses
the measures you can take to protect yourself—as well as profit—during
the difficult times that lie ahead. He also outlines a specific
three-step plan that will allow you to preserve wealth and protect the
purchasing power of the savings you have worked a lifetime to
accumulate.
by Peter D. Schiff
”The
substitution of paper money for
metallic
currency is a national gain:
any further
increase of paper
beyond this is but
a form of robbery
... all holders of
currency lose,
by the depreciation of its value,
the exact equivalent of
what the issuer
gains. ”
John
Stuart Mill
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Inflation 2%?
Do You really thrust the
people
who are telling You that ?
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The Economics of Fiat Money ( Free Downloads of books and
audio )
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I.
Introduction by Murray Rothbard
II. Money in a Free Society
1.
The Value of Exchange
 2. Barter
3.
Indirect Exchange
4. Benefits of Money
5.
The Monetary Unit
6.
The Shape of Money
7.
Private Coinage
8.
The Proper Supply of Money
9.
The Problem of Hoarding
10.
Stabilize the Price Level?
11.
Coexisting Moneys
12.
Money-Warehouses
13.
Summary
III. Government Meddling With Money
1.
The Revenue of Government
2.
The Economic Effects of Inflation
3.
Compulsory Monopoly of the Mint
4.
Debasement
5.
Gresham's Law and Coinage
6.
Summary: Government and Coinage
7.
Permitting Banks to Refuse Payment
8.
Central Banking: Removing the Checks on Inflation
9.
Central Banking: Directing the Inflation
10.
Going Off the Gold Standard
11.
Fiat Money and the Gold Problem
12.
Fiat Money and Gresham's Law
13.
Government and Money
IV. The
Monetary Breakdown of the West
1. Phase I: The
Classical Gold Standard, 1815-1914
2. Phase II:
World War I and After
3. Phase III:
The Gold Exchange Standard (Britain and the United States) 1926-1931
4. Phase IV:
Fluctuating Fiat Currencies, 1931-1945...
5. Phase V:
Bretton Woods and the New Gold Exchange Standard (U.S.) 1945 1968
6. Phase VI: The
Unraveling of Bretton Woods, 1968-1971
7. Phase VII:
The End of Bretton Woods: Fluctuating Fiat Currencies, Aug-Dec, 1971
8. Phase VIII:
The Smithsonian Agreement, December 1971-February 1973
9. Phase IX:
Fluctuating Fiat Currencies, March 1973-? |
Copyright 1980 by
The Ludwig von Mises Institute
Download
the full
text free here
in PDF,
in .PDB, or
in .LIT
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Murray
Rothbard
Ludwig von Mises Institute,
1994, 158 pgs.
Murray Rothbard begins this
outstanding book by calling attention to a paradox. The Federal Reserve
System enjoys virtual immunity from Congressional investigation. The
few who propose to subject the Fed to even minimal scrutiny, such as
Henry Gonzales of Texas, at once find a consensus arrayed against them
(Pp. 1 ff.). They threaten the stability of the market; since, it is
alleged, only the Fed's independence blocks the onset of uncontrollable
inflation.
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