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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 t
o 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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Short news
Crisis in Belgium:
100 days after the Belgian general elections, the Belgian politicians are still unable to form a government. 20 days after his appointment as “royal scout” by Belgium’s King Albert II, in an effort to defuse the situation, Mr Van Rompuy's   efforts have come to nothing.

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.
US$ money stock m3 us$
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 inflationECB-refinance-rate 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 j s millmonetary 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.

euro paper money

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 us house pricesof 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...

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.

eu mortgage debt

 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.

debt service ratioBut 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 :

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.

Paul Vreymans


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.

northern rock bbc

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



(1)  See also: The Euro: the Gamble with People's Prosperity that went terribly wrong
(2)  Source M3 statistics: ECB   see
(3) The ECB and its Monetary Analysis, Goldman Sachs Economic Research,
(4)  Is Inflation Always and Everywhere a Monetary Phenomenon? Paul De Grauwe, Magdalena Polan, (2005)
(5) Savings data Source: OECD- see
(6)  CDO: Collateral Debt Obligation sometimes with dubious underlying collatera

Remarks or suggestions ?  please contact us at  contact

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:
further increase of paper
beyond this is
but a form of robbery

... all holders of
currency lose,
by the depreciation of its
the exact equivalent of
what the
issuer gains.

John Stuart Mill
Inflation 2%?
Do You really thrust the people who are telling You that ?

The  Economics  of  Fiat Money    ( Free Downloads of books and audio  )

I. Introduction by Murray Rothbard

II. Money in a Free Society

1. The Value of Exchange
what has government done to our money2. 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 

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