Monetary failure is becoming inevitable


by Alasdair Macleod, GoldMoney:

This article posits that there is an unpleasant conjunction of events beginning to undermine government finances in advanced nations. They combine the arrival of a long-term trend of rising welfare commitments with an increasing certainty of a global-scale credit crisis, in turn the outcome of a combination of the peak of the credit cycle and increasing trade protectionism. We see the latter already undermining the global economy, catching both governments and investors unexpectedly.

Few observers seem aware that an economic and systemic crisis will occur at a time when government finances are already precarious. However, the consequences are unthinkable for the authorities, and for this reason it is certain such a downturn will lead to a substantial increase in monetary inflation. The scale of the problem needs to be grasped in order to assess how destructive it will be for government finances and ultimately state-issued currencies.


Listening to recent commentaries about the repo failures in New York leads one to suppose there is insufficient money in the system. This is not the real issue, as the chart below of the fiat money quantity for the dollar clearly shows.

Water graph
The fiat money quantity is the amount of fiat money (in this case US dollars) both in circulation and held in reserve on the central bank’s balance sheet. Before the Lehman crisis, it grew at a fairly constant compound growth rate of 5.86%. Since the Lehman crisis, it has grown at an average of 9.45%, even after the slowdown in its rate of growth that started in January 2017. FMQ is still $5 trillion above where it would have been today if the massive monetary expansion in the wake of the Lehman crisis had not happened. If there is a shortage of money, it is because the process of debt creation to fund current expenditure is spiralling out of control.

It is not just the US. If we take similar (but less detailed) figures for FMQ in other major nations by adding together broad money M3 and central bank balance sheets, we find that it has increased at varying rates for the most important economies. In China, the compound annual growth rate has been 12%, though the growth in Japan at 5.2% and in the Eurozone at 4.9%. has been more subdued, reflecting stagnant levels of bank credit. When for the lack of any other measure statisticians use a GDP money total as a substitute for defining economic progress, we should not be surprised to see that the economies with the greatest rate of monetary growth are reckoned to be the best performing.

Just as GDP tells us nothing about human progress and its benefits to society, other uses of money as a control mechanism for economic management are equally misleading. Much of the monetary expansion has been to fund unproductive government spending. Most of the balance after the government’s cut has fuelled speculation in the financial sector and has funded consumer credit for those whose savings have been tapped out. Not revealed by the acceleration of money supply growth is the wealth transfer effect which impoverishes every productive individual for the benefit of governments, the banking system and the bank’s favoured customers, who are in the main large corporates and directly or indirectly the hedge funds.

Decades of impoverishment by monetary inflation, which has quickened since Lehman, is a very serious matter and is behind the fragility of economic systems dominated by government spending deficits. The reason there appears to be not enough money is because the acceleration of government liabilities in nominal currency terms is catching up with them. Laurence Kotlikoff’s famous 2012 estimate of the US Government’s future commitments of a net present value of over $222bn is very much alive on arrival.

It would be more accurate to say the figure for the US is trending towards infinity. It is already infinity in Japan and the Eurozone, where negative interest rates and bond yields offer the basis for the net present value calculation. As in most things financial, the public is blissfully unaware of the true implications of low and negative interest rates and ultra-low bond yields. They take the view that very low interest rates permit their government to borrow as much as it likes to provide the public with new hospitals, schools and the like. It is a case of fools of politicians and central bankers having turned everyone else into fools, and the few who realise it have no idea how to reverse the process. What they do not see is the government cannot now fund public healthcare and pensions, which make up the bulk of future obligations in a welfare state, without accelerating monetary debasement even more.

No one can know what the true figure is for future government liabilities, of which welfare is an increasing component. Politicians, who claim that a week in politics is the long term, fail to see any problem. The few governments which have raised retirement ages have done so to deal with escalating current welfare liabilities, not addressing those of the future that will lead ultimately to the destruction of what as Westerners we generally agree is civilised democratic society. That is their successors’ problem.

If history and reasoned economic theory is any guide, the demands for credit by the state will terminate in the destruction of government currencies. For the truth of the matter is inflation of money and credit has created the illusion we can all live beyond our income, our income being what we produce.

Nothing, with the sole exceptions of a central bank and its commercial charges can make money without having to advertise for it: the seigniorage is simply taken without public consent. Without questioning how it arises, the extra money allows us to indulge in all our flights of fancy until at some time reality strikes. Rather like Monty Python’s glutton, Mr Creosote, can we force in a little more inflation before we all explode?[i]

The credit cycle is now on the turn

The complaint that the current precarious position faced by major economies is due to a shortage of money is untrue. The problem is one of escalating expenditures, and anyway, the response to any shortage, as we saw recently with problems in the US repo market, is simply to issue more money. But it is no solution, only making the eventual crisis worse.

It is easy to increase the quantity of money, but virtually impossible to increase the quantity of goods to accompany it. For this reason, increases in the quantity of money disadvantage ordinary people, the everyday producers of goods and services in small and medium sized enterprises. And with more money in circulation but the same quantity of goods, the pressure mounts for prices to rise. For a time, consumers can escape price rises by substituting cheaper goods from abroad. This reduces the impact of price rises in the domestic market. Savers are also beneficial for price stability, because they defer their purchases to a future date. But in the absence of savers taking the steam out of inflation-fuelled demand, and contemporary American tariffs on Chinese imports designed to limit them by erasing the price advantage handed to China by America’s monetary inflation, the effect is bound to raise the general level of prices.

Consequently, legacy businesses in America have hoped for a bonanza through not being forced to compete with China. For too long, they have seen the costs of production rise, driven by rising input costs, government regulations, their own expanding bureaucracies, and the natural tendency for expenditure to rise towards the income available. Having been bound hand and foot by red tape they hope that tariffs will protect them from foreign competitors who are not. They maintain their higher uncompetitive prices only to find that consumers, who have not had the benefit of the new free money, are not prepared to pay them or are unable to afford them. Sales volumes suffer and losses begin to accumulate. An international problem provoked by trade protectionism becomes a domestic setback, which is the transition currently hitting the US economy.

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