Why
the above is so can be gleaned by looking at a few figures. Total
US debt (private + public) is presently about US$32 trillion, but
the total supply of US dollars is only about $9 trillion. This means
that if every US dollar in existence was put towards the repayment
of debt the average creditor would only receive about 28c on the
dollar. Also, if we assume an average interest rate of 6% on the
$32T of debt then the annual interest bill is about US$1,900 billion.
However, the increase in the total US money supply over the past
12 months was 'only' $420 billion. In a nutshell: there is nowhere
near enough money in existence to pay-off the current debt and there
is nowhere near enough new money created each year to even pay the
interest on the debt.
But
isn't the above an argument for massive deflation?
No,
in a world in which there are no constraints on the amount of new
money that can be created 'out of thin air' it's an argument for
inflation as far as the eye can see. The crux of the matter is this:
when you create a "Ponzi scheme" -- any scheme where money
coming in from new investors is needed in order to meet the commitments
made to current investors -- the scheme can't continue to function
unless the new money keeps coming in at a fast enough rate. Once
the rate of in-flow slows the scheme doesn't just experience a hiccup,
it collapses. This is because the first failure to fulfill a promised
return exposes the true nature of the scheme.
The
current monetary system is effectively a Ponzi scheme whose survival
relies on the total supply of credit and money -- the so-called US$
short position -- continuing to expand (the way the system is designed
there can never be enough money to pay-off existing debts). So, don't
expect that the major stakeholders in the system (the US Government,
the Fed, the commercial banks, the GSEs, the money-market funds,
the Wall St financial houses) will decide to just hunker down and
weather a brief period of deflation. That's really not an option
for them.
But
if US consumers decide to stop increasing their debt loads or, heaven
forbid, decide to start REDUCING their debt loads, what could be
done to prevent a contraction in the total supply of credit?
At
this stage there is no evidence that the credit expansion is about
to go into reverse, but if a slowdown in credit growth did begin
to become an issue then the Fed could follow through on its promise
to push down long-term interest rates via the large-scale buying
of bonds. The Fed would not necessarily limit itself to US Government
bonds but might, if it perceived that the situation warranted more
drastic action, also buy large quantities of agency debt and asset-backed
securities. The likely SHORT-term effects of such action on the part
of the Fed would be a) a reduction in the interest burden of US consumers,
b) another mortgage re-financing binge, c) a monetary injection into
the economy, d) higher inflation expectations, and e) a weaker dollar.
There
are other ways to ensure a continuation of the inflation trend in
the event that genuine deflation becomes a real threat, but the Fed's
ability to monetise unlimited quantities of debt is by far the most
potent inflationary weapon in the arsenal. A central bank that takes
the 'printing press route' never has any trouble devaluing the currency.
Instead, the problem they always end up having is figuring out how
to prevent inflation expectations from spiraling out of control.
Something
else that needs to be considered is that there is no precedent throughout
history of a country at war experiencing deflation. The US is presently
at war, the only difference being that this war is not being fought
against a specific enemy. Rather, it is being fought against a methodology
(terrorism). The nature of this war most likely prevents it from
being won by military means, but this detail isn't stopping the US
from TRYING to win it by military means.
One
final comment: the financial-market and economic conditions during
the second and third quarters of this year are likely to bring about
the return of deflation as a 'hot topic'. This is what we warned
about in our 22nd March commentary. However, a 20%-25% drop in the
copper price following a 100% rally is not a sign of deflation, it's
just a routine bull-market correction. A sharp decline in a drastically
over-priced stock market is not a sign of deflation, it's just part
of the natural process of reverting to the mean. A pullback in the
gold price and a bounce in the US$ are not signs of deflation, they
are just consequences of the fact that markets never get where they
are going in a straight line. A slowdown in the reported economic
growth rate is not a sign of deflation, it's just 'par for the course'
because there wasn't much real growth to begin with.
Steve Saville
email: sas888_hk@yahoo.com
Hong Kong
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We've
recently received several e-mails from subscribers asking for our
take on the idea that the huge amount of debt in the US represents
a massive US$ short position. The idea, which is explained in detail
by George Paulos and Sol Palha in