This post was first published at Bawerk.net [9]. You may also follow us on @EBawerk [10]
As is clear to all with half a brain the production of un-backed fiat money distorts the economic system. Simply told, when an entity in society is given monopoly to manufacture medium of exchange at its own discretion they will harness this power. Slowly at first, unsure about its effects, but always testing the limits of the privilege bestowed upon them.
As always, they will overexploit the power. They will manufacture money and give it to the masters that coercively secure the continuation of the power. The masters will obviously spend the money, creating a transaction in which nothing is payment for something. These transactions are by definition unsustainable because they violates Say`s law. We call them “bubbles”
In a free market supply is used to create its own demand. When people spend fiat money they exercise demand without providing supply. Said in other words, spending fiat money is tantamount to capital consumption and makes society poorer.
While the boom that follows money spending feels good, it must inevitably come to an end because the economic system cannot maintain the constellation that was induced by the money printing in the first place. Within the boom lays the seed for the necessary bust.
We have made a metric that sums up fiat money in its purest sense and compared that to the underlying trend growth of nominal GDC.
Our hypothesis is simple: if money growth exceeds the GDC metric a deflationary busts will inevitably come. If authorities refuse to accept reality and print more fiat money at the first sign of bust, they may “save the day” but they will “ruin tomorrow”!
For every action taken there will be an equal and opposite reaction! When the fiat masters go too far they create the set-up for an imminent deflation.
We looked at this relationship and as the chart below show, a boom-bust cycle based on monetary expansion is clearly visible.
Source: Federal Reserve of St. Louis (FRED), own calculations
Our main concern is obviously what happens when the equal, but opposite reaction comes as a consequence to the monetary experiment dubbed the “Bernanke-put”.
A secondary concern is indirectly derived from this. Money printing tears the social fabric apart and people react by taking up massive amounts of debt; debt that will never be repaid in currency units of equal purchasing power.
Now, if the equal reaction comes, that will raise the real burden of outstanding debt, which consequently will bankrupt all debtors.
The next chart looks at various sovereigns’ roll-over risk for 2014. The exceptionally large amount of debt taken on since the financial bust in 2008 will forever constitute a massive risk for the issuing country as debt is never repaid, only rolled-over, that is old debt is paid with new debt.
Source: Bloomberg, International Monetary Fund (IMF - WEO), own calculations
By this it is obvious to us that deflation simply cannot be allowed to happen! Our monetary masters will lose everything if they even flirt with the mere idea! Witness the taper scare this summer!
And since we are getting close to the next cycle low, why even bother try.
Source: National Bureau of Economic Research (NBER), Bureau of Labor Statistics (BLS), own calculations
Concluding Remarks
We leave the last word to the real Maestro
"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."
- Ludwig von Mises