Guest Post: How the Paper Money Experiment Will End

Tyler Durden's picture

Submitted by Philipp Bagus via the Ludwig von Mises Institute blog,

A paper currency system contains the seeds of its own destruction. The temptation for the monopolist money producer to increase the money supply is almost irresistible. In such a system with a constantly increasing money supply and, as a consequence, constantly increasing prices, it does not make much sense to save in cash to purchase assets later. A better strategy, given this scenario, is to go into debt to purchase assets and pay back the debts later with a devalued currency. Moreover, it makes sense to purchase assets that can later be pledged as collateral to obtain further bank loans. A paper money system leads to excessive debt.

This is especially true of players that can expect that they will be bailed out with newly produced money such as big businesses, banks, and the government.

We are now in a situation that looks like a dead end for the paper money system. After the last cycle, governments have bailed out malinvestments in the private sector and boosted their public welfare spending. Deficits and debts skyrocketed. Central banks printed money to buy public debts (or accept them as collateral in loans to the banking system) in unprecedented amounts. Interest rates were cut close to zero. Deficits remain large. No substantial real growth is in sight. At the same time banking systems and other financial players sit on large piles of public debt. A public default would immediately trigger the bankruptcy of the banking sector. Raising interest rates to more realistic levels or selling the assets purchased by the central bank would put into jeopardy the solvency of the banking sector, highly indebted companies, and the government. It looks like even the slowing down of money printing (now called “QE tapering”) could trigger a bankruptcy spiral. A drastic reduction of government spending and deficits does not seem very likely either, given the incentives for politicians in democracies.

So will money printing be a constant with interest rates close to zero until people lose their confidence in the paper currencies? Can the paper money system be maintained or will we necessarily get a hyperinflation sooner or later?

There are at least seven possibilities:

1. Inflate. Governments and central banks can simply proceed on the path of inflation and print all the money necessary to bail out the banking system, governments, and other over-indebted agents. This will further increase moral hazard. This option ultimately leads into hyperinflation, thereby eradicating debts. Debtors profit, savers lose. The paper wealth that people have saved over their life time will not be able to assure such a high standard of living as envisioned.

2. Default on Entitlements. Governments can improve their financial positions by simply not fulfilling their promises. Governments may, for instance, drastically cut public pensions, social security and unemployment benefits to eliminate deficits and pay down accumulated debts. Many entitlements, that people have planned upon, will prove to be worthless.

3. Repudiate Debt. Governments can also default outright on their debts. This leads to losses for banks and insurance companies that have invested the savings of their clients in government bonds. The people see the value of their mutual funds, investment funds, and insurance plummet thereby revealing the already-occurred losses. The default of the government could lead to the collapse of the banking system. The bankruptcy spiral of overindebted agents would be an economic Armageddon. Therefore, politicians until now have done everything to prevent this option from happening.

4. Financial Repression. Another way to get out of the debt trap is financial repression. Financial repression is a way of channeling more funds to the government thereby facilitating public debt liquidation. Financial repression may consist of legislation making investment alternatives less attractive or more directly in regulation inducing investors to buy government bonds. Together with real growth and spending cuts, financial repression may work to actually reduce government debt loads.

5. Pay Off Debt. The problem of overindebtedness can also be solved through fiscal measures. The idea is to eliminate debts of governments and recapitalize banks through taxation. By reducing overindebtedness, the need for the central bank to keep interest low and to continue printing money is alleviated. The currency could be put on a sounder base again. To achieve this purpose, the government expropriates wealth on a massive scale to pay back government debts. The government simply increases existing tax rates or may employ one-time confiscatory expropriations of wealth. It uses these receipts to pay down its debts and recapitalize banks. Indeed the IMF has recently proposed a one-time 10-percent wealth tax in Europe in order to reduce the high levels of public debts. Large scale cuts in spending could also be employed to pay off debts. After WWII, the US managed to reduce its debt-to-GDP ratio from 130 percent in 1946 to 80 percent in 1952. However, it seems unlikely that such a debt reduction through spending cuts could work again. This time the US does not stand at the end of a successful war. Government spending was cut in half from $118 billion in 1945 to $58 billion in 1947, mostly through cuts in military spending. Similar spending cuts today do not seem likely without leading to massive political resistance and bankruptcies of overindebted agents depending on government spending.

6. Currency Reform. There is the option of a full-fledged currency reform including a (partial) default on government debt. This option is also very attractive if one wants to eliminate overindebtedness without engaging in a strong price inflation. It is like pressing the reset button and continuing with a paper money regime. Such a reform worked in Germany after the WWII (after the last war financial repression was not an option) when the old paper money, the Reichsmark, was substituted by a new paper money, the Deutsche Mark. In this case, savers who hold large amounts of the old currency are heavily expropriated, but debt loads for many people will decline.

7. Bail-in. There could be a bail-in amounting to a half-way currency reform. In a bail-in, such as occurred in Cyprus, bank creditors (savers) are converted into bank shareholders. Bank debts decrease and equity increases. The money supply is reduced. A bail-in recapitalizes the banking system, and eliminates bad debts at the same time. Equity may increase so much, that a partial default on government bonds would not threaten the stability of the banking system. Savers will suffer losses. For instance, people that invested in life insurances that in turn bought bank liabilities or government bonds will assume losses. As a result the overindebtedness of banks and governments is reduced.

Any of the seven options, or combinations of two or more options, may lie ahead. In any case they will reveal the losses incurred in and end the wealth illusion. Basically, taxpayers, savers, or currency users are exploited to reduce debts and put the currency on a more stable basis. A one-time wealth tax, a currency reform or a bail-in are not very popular policy options as they make losses brutally apparent at once. The first option of inflation is much more popular with governments as it hides the costs of the bail out of overindebted agents. However, there is the danger that the inflation at some point gets out of control. And the monopolist money producer does not want to spoil his privilege by a monetary meltdown. Before it gets to the point of a runaway inflation, governments will increasingly ponder the other options as these alternatives could enable a reset of the system.

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fonzannoon's picture

It will end in digital money. 

Look at this mindfuck....

Look at this "crusty veteran" Cashin try to equate a 10 bil taper from 85 bil in QE to 75 bil to Volker hiking rates to 14% in 1982 and "choking inflation to death" and  then he backed off because the Mexican Peso was in trouble.

Is that some shit or what?


nope-1004's picture

Personally, I'm hoping it ends in public hangings, as well.


There is no taper.  Only lies about it.  FED has been monetizing North of 100 Bil per month for years.  Add up all the back door shenanigans and you'll arrive at the same conclusion.




Thats why you have to pick up these free bitcoins while it lasts..I am up to FREE 1/2 a bitcoin a week, forever..or until the site dies..haven't used a dime..

AlaricBalth's picture

From a distance, this portrait looks alot like Bernanke hung amongst a wall papered with US currency.

max2205's picture

Sure...ain't never going to happen

SafelyGraze's picture

Old Financing:

borrow money. build a house. borrow money. add/improve on house. 

bank lists house on its assets. as house value increases, so does the bank asset. owner pays off mortgage and then dies.

Recent Financing:

borrow money. buy a house. house value declines. owner defaults. bank doesn't evict. bank continues to up-value the house. former owner is now a squatter.

Emerging Financing:

borrow money. build a house. internal walls is made with silver rods. each month, the owner sells a rod and uses the cash to pay the monthly mortgage. when the rods have all been liquidated, owner walks away.



Richard Chesler's picture

Paper Money Excrement.


My eyes playing tricks on me.

woerm's picture

Paper money doing what it always does chap n to the x

Had been wondering what the trigger would be looks like Chicom letting one of their 'investment' vehicles collapse will time in with Turkish delight and Vensuleian(?) socialism.


buckle up this may be a bumpy ride

new game's picture

death march to monetary concentration camp of inflationary chokehold til last breath.

Manthong's picture

OK, so Governor Walker has been in Wisconsin for like what.. 2 years or so?

I just heard from a noted talk show entertainer that the state is running an  f’n $ 1 Billion  SURPLUS  now and that he is pushing legislation that will rebate the surplus to property tax payers.

Stick THAT up your posteriors, you liberal MF’s (meant as a literal.. you all probably do your mothers and grannies).

SAT 800's picture

Walker for President ! Let's get the ball rolling!

Manthong's picture

whoa.. now that's an idea.. 

Wisconsin's loss might be the country's gain.


I'm in if no skeletons in his closet. 

Manthong's picture

..everybody has some bones somewhere..

there is no total purity or perfection..

as Daniel Hannen noted, man is fallen..

let's work with that.. except if you are a golf addict choom fool that is owned by GS. 


NoDebt's picture

My own towship went from a $200K per year DEFICIT to a $500K per year SURPLUS after throwing the bums off the board and severing ties with their cronies.  Put a nice group of conservatives in there, found out there was so much corruption we called the District Atty. on some of the old board members, and then set about fixing the problems.  It took ONE YEAR to realize the radical improvement in fiscal health and NOT ONE SINGLE SEVICE WAS CUT TO ACHIEVE THAT.

I could get behind Scott Walker a lot easier than I could be persuaded to feign excitement for the Fat Man.

Dick Buttkiss's picture

No real reformer can get elected President or not be assassinated if he/she were.

The Fed/MIC/NSA/CIA rule.

At least until Bitcoin and friends end-run them, stripping them of their power.

Talleyrand's picture

Nobody for president, please....or governor or congress or any of that. Enough already!

When will people learn? Probably not in my (your) lifetime. Oh, well.

Dick Buttkiss's picture

"I believe we are headed now into a breakup of the nation into smaller units, but this time there will be no reconstituting the original USA as in 1865." — James Howard Kunstler,

Yes, we are, and I fully expect it to happen before the decade is out. States Rights is a resurgent phenomenon, after all (drug legalization, Obamacare nullification, etc.), and as the abysmal failure of our vaunted experiment in federative government sinks in, I believe the American people are going to experience the same sense of futility that their Soviet counterparts did, "We pretend to work, and they pretent to pay us" being their running joke. 

How long, then, before something like it — "We pretend to rule, and they pretend to let us"? — so infuses the public consciousness that the American people collectively Just Say No and walk away?

It's over, after all, and surely, at some level, we all know it.

brewing's picture

Nebraska looking to do the same.

Joeman34's picture

Check out what Bruce Rauner is trying to do for IL:

Dare we say the tide is beginning to turn??

WillyGroper's picture

That Kock bros. sellout?

You can be serious, You believe that?

Tall Tom's picture

Government Unionized Workers took a large cut in benefits because of Scott Walker's actions.


It would help if the Federal Government Employees lost some of thier pension compensation and benefits also.


It is not a "cure all" but it is a good start.


You know that when Government was "shut down" the Government Employees were delighted to take an UNSCHEDULED PAID VACATION at Taxpayer Expense. That is why they want to Shut Government Down again.







fonestar's picture

If eBay and Google. start accepting Bitcoin it will go to thousands of dollars per BTC this year.

maskone909's picture

hope so.  gold silver and BTC is the way to go. 

SAT 800's picture

If pigs had wings they could fly.

fonestar's picture

We are making history while the losers are being left behind.  Enjoy the SHTFantasy'ing fellas!

FeralSerf's picture

Not necessarily. Ostriches have wings and they don't.

midtowng's picture

I'm starting to think that people pushing Bitcoins are part of the pump-and-dump crowd.

fonestar's picture

Bitcoin isn't some stock that can be pumped.  It's $780 today because it's the vastly superior product, not because anyone pumped it there.

rubiconsolutions's picture

"Thats why you have to pick up these free bitcoins while it lasts"

Isn't that precisely what got this country into trouble? Thinking that you can get 'sumthin for 'nothin? Can't create wealth the old fashioned way? Just print it! Isn't that what you are saying? What a load of crap.

fonestar's picture

Right, the pinnacle of mathematical, networking and cryptograpic genius is tantamount to "nothin" according to braindead morons on Zerohedge.  

jomama's picture

luckily for all us incredibly stupid idiots at ZH, we've got you around to set us straight!

glad to see you're so charitable so sit around here 'educating' us every chance you get to open your cum recepticle.

midtowng's picture

If Bitcoin was such a great deal then why are you spamming for it? Shouldn't you be trying to keep it a secret while you accumulate Bitcoins?

fonestar's picture

Personally, I'm not worried about it.  It seems 95% of people will not get Bitcoin no matter what.

Tall Tom's picture

Without widespread acceptance the BTC is doomed to failure.


But in the chance that there is a greater acceptance of the Cryptocurrency...


How are you planning to account for the growing data size of the BLOCKCHAIN??? My Internet Downlink speed is not growing anywhere near as rapidly as the Blockchain size of BTC.


That means that if BTC progresses into wider acceptance then the TIME for transactions increase Exponentially as there are limits to download and upload speeds.


If you claim that there will be a Central Hub, Supernodes, that will store any portion of those transactions, then the Cryptocurrency is subject to control by another entity.


Anonymity will disappear.


The software architechture is flawed.


I am not the only one whom knows this...


Watch the video from


You cannot hide the truth, fonestar.


fonestar's picture

That is totally false.  Bitcoin already has been elected by the technical elite as the currency and those are the only people who really matter on this planet.  Joe Six-Pack and Farmer Bob are superfluous and they can go fruck themselves.

Tall Tom's picture

...the technical elite as the currency and those are the only people who really matter on this planet.


Well when you need your Toilet fixed I am certain that you will not be paying in Bitcon. What good is it if it is not a viable Curency? If I cannot trade it for what I want then it serves no purpose.


And if you are looking toward "Corporate Plumbers" and "Corporate Auto Mechanics" then you are really detached.


Enjoy your Corporatocracy. That is what you promote. That is fascist. You are part of the problem, fonestar.

fijisailor's picture

Incredible.  I just won .00000228 bitcoin.  I'm rich.  Try again in 1 hour.

Herd Redirection Committee's picture

OMG, thats almost 0.01 USD!  Actually its 1/10th of 0.01 USD, but hey...

Bearwagon's picture

Maybe he simply does not know that the less you have to pay for something - the less is free.

Landotfree's picture

Public hangings will do nothing to stop anything.   Billions of unfunded walking liabilities will have to be liquidated.  The use of credit as money has been going on for 1000s of years.... why?  Because humans want something for nothing including the majority of the 7 Billion on this floating rock.   

"same conclusion"

Whether or not the Fed does this or that will not eliminated the same conclusion.   Attaching interest to your medium of exchange will eventually get you to unable to grow at an exponential growth, collapse and then liquidation of the unfunded walking liabilities.

Sounds like you are into the Hilter way of liquidation of the walking unfunded liabilities.  Quick.  The world hired Hilter to do within a decade what it would have taken 40-60 years without him.   



Duke of Earl's picture

"Public hangings will do nothing to stop anything. "


You never know unless you try.

Landotfree's picture

I wonder who the unlucky SOB is... I mean there is  7 billion to choose from.   Popcorn ready.

midtowng's picture

Public hangings are the ONLY thing that ever stopped corruption.

Landotfree's picture

That does not address the issue.... 

The system is collapse due to Math i.e. humans believing they can supply and demand exponential growth.  So, King George hangs X amount of people then I guess there is no corruption, good luck with all that.


Good luck in your hangings... unless of course you are the one they come for.   :)


Duke of Earl's picture

This is an oversimplification.  Human beings do not believe that at all.  I highly doubt if government officials do despite what they say, note the massive amounts of commodity purchases going on by the wealthy.  The governments have painted their way into a corner and the only way out is through collapse.  The goal is to kick the can to the next guy in line.

Nobody is going to get elected by saying they can cause more pain now to avoid potential pain in the future.  People get into power by telling everyone that they can take money away from others and give it (through services or directly) to whomever they happen to be speaking to at the moment.

If you can devise a way to stop the current economic death spiral without violence as a result, I'd love to hear it.