Central Bank Independence to create 'Economic Stability'

I've taken some interesting points from article in which Ben Bernanke states Central Banks must keep their independence in setting interest rates. 

"Restricting banks' ability to execute monetary policy would lead to economic instability and "boom-bust cycles."

The Bank of England has been independent since 1997. Since that time we have witnessed the largest credit boom and bust since the Great Depression. Through all those prior years monetary policy was driven by the Governments Chancellor. So how does a Central Banks independence solve the boom bust dilemma as claimed above?

"Politicians generally prefer holding interest rates low, as a means of stimulating the economy and boosting jobs."

Remind me what are interest rates at now as I write? 0.5% of a percent, the lowest in the BoE's 300 plus year history, since it was established in 1694. I don't think we can actually go much lower, can we? Inflation, as measured by RPI is the highest since our last recession and these guys still have their foot to the floor.

"Thus political interference in monetary policy can generate undesirable boom-bust cycles that ultimately lead to both a less stable economy and higher inflation,"

You don't have to be an economic wizard to see the anomaly in our present time.

How anyone listens to these Monetary planners is beyond me. Markets don't need people like this, something Hugh Hendry states quite aggressively in this video. Markets should 'purge the system of its rottenness' - now there's an idea? What wrong with entities going bankrupt? Its what differentiates real market economies to socialist dictatorships. It frees up resources to meet peoples genuine needs, one of the reasons we live such a relative pleasurable existence. As Mr Hendry states, 'We can spread this over 20 years or we can spread it over 3 years'. My bets are on the former.

The Descent of Niall Ferguson?

We came close to financial collapse, Wall Streets big Investment banks went bankrupt or were merged into other banks, the IMF bailed out various countries from monetary implosion, Sterling plunged, Governments turned to Socialist solutions, the myth of houses being a 'safe investment' was derailed. In all the turmoil with every asset in sight heading south, historian Niall Ferguson was on our screens again, this time with a series titled "The Ascent of Money" to promote his new book. A six part series that looked at the historical impact of finance within human society and how it has evolved, into the modern system we now use in our economies. I personally enjoy reading Niall Ferguson's books and there are some interesting titles to his name, my favourite being Empire: How Britain Made the Modern World. After the last episode there was an open web chat in which he answered peoples questions, which can be found here. Like the television series, Prof Ferguson seemed to have flawed analysis of economic matters, such as deflation and inflation which I wish to explain briefly here. Inflation and deflation is strictly a monetary phenomenon, it is caused by an increase in paper money compared with the goods and services in an economy. This shows up as rising prices, however the goods do not rise in price from market forces, but from monetary expansion. For the sake of this article, I may refer to deflation as falling prices, but technically it is a falling money supply. However I will use this definition to elaborate on Prof Ferguson points in question. I have selected some of the quotes he made in the online discussion that I found interesting.


"Well, right now Ben Bernanke is more worried about deflation than about inflation. But if he's successful we can soon revert to worrying about inflation. As I said in an earlier post, central banks today do not want 0% inflation (i.e. price stability). It limits the room for monetary policy too much. Are we going to see a big surge in inflation after this crisis is over? I frankly doubt it. The Fed can mop up a lot of this excess liquidity quite easily, as the Bank of Japan did after the end of quantitative easing."

The above analysis is flawed, in many aspects. First of all, that we are suddenly worried about deflation. This is a myth, as the past couple of decades have been deflationary. As I've said before market forces are always deflationary, people reinvest capital to increase productive capacity, thus reducing the cost of goods and services. Prof. Ferguson confuses general deflation, with the aspect of deflation that Ben Bernanke is worried about, that is asset price deflation - houses and stocks. As the US and UK have consumption debt based economies, where the 'wealth' is based on the price of the above assets, when these are falling in value then the economy contracts. This is what the Western Central Banks are worried about, as our whole economy revolves around these assets. They will inflate these assets at all costs, hence why they want to print money. History has always shown governments will do this as people want the government to take action. Prof. Ferguson does not mention any of this which is a big omission. He also doesn't mention it in the television series.

Apart from the first episode there is no great mention about inflation. Inflation is a purely monetary phenomenon, which amazingly he doesn't seem to explain in great depth. In order to obtain the 'price stability' he references above, central banks must constantly inflate the currency as the prices of goods and services continue to fall. Achieving price stability is a path to periodic financial crisis. Price stability helped cause the Great Depression, as the FED had to inflate during the 1920's in order to ensure inflation was ticking along, fighting against the deflationary forces of industialisation. Then when the bust came in, they tried to inflate to keep inflation up (i.e. keep wages, agriculture and stock market prices high), however they were beaten in the end by the gold convertibility so deflation won in the end. Rather than the economy resuming normal operation it stagnated for years due to the huge inflation in the proceeding years, accompanied by the draconian measures that were introduced as the government constantly interfered during the bust. It wasn't deflation that made the great depression, it was the inflation in the stock market. Then there was the stagflationary seventies. All currencies were off gold, therefore governments this time could inflate so inflation reached as high as 25% in Britain. Again the result was the same - economic hardship for years. It was inflation again in the 50's and 60's into asset prices that caused this as central banks looked for 'price stability'. Yet again, we are following the same foolhardy decisions, as price stability causes financial instability.

When Dr Ferguson mentions this price stability he says it limits the room for monetary policy. Does he really understand what he is saying here? The only thing it limits is the economies ability to re-deploy its resources efficiently and effectively. It has helped cause the stock market bubbles and the housing bubbles with the recent one, being one of the prime reasons we find ourselves in this mess as Greenspan and Co decided we had to pump cheap money in the system to ensure 'Price Stability' to combat these deflationary forces. They expanded the money supply so much that the West quite simply misallocated its resources in the wrong areas, hence the major correction we are now going into. Capital should always be scarce despite what people say, as it tries to direct a scarce amount of resources in the real economy into the required productive channels.

Then we come onto his other comment regarding if we going to see a big surge in inflation, in which he doubts we will. His reasoning is that we will be able to mop up any excesses like Japan. Like Japan did? As I have mentioned before, and unfortunately our governments have begun implementing this policy, Japan cut interest rates to 0% and tried to inflate to cure their downturn in the 90's but all it did was kill the economy. They also tried the new buzz word in the media "Quantitative Easing" which is effectively printing money, as I have earlier warned about. The reason Japan didn't experience inflation domestically, was that they exported this excess money to the world. Japan exported inflation to the world. You have probably heard of the Yen Carry trade well this is what it was in effect, people buying up huge amounts of Yen at cheap rates and putting the money to use in other countries where the returns were higher. It was also the reason for the Yens surge this year, and the deleveraging we saw in the autumn and winter of 2008 as these returns evaporated and the Yen increased in value against all currencies - people had to sell to cover these loses. This is also one of the causes of our asset booms in the stock market and housing. If it wasn't for this and the fact Japan is a huge creditor nation who have a trade surplus, they would have experienced huge inflation. So then we ask the question, how will the West mop up this excess money if the majority of the worlds economies are doing it? Quite simply, they can't, once this money is in the system along with less goods and services (which is what is happening at the moment as businesses won't invest) inflation is inevitable. The only way to stop it is by raising interest rates to double digits, a policy politicians don't particularly like, as Margaret Thatcher found when she became a demonised figure. Our economy is based around debt, so they are not going to be doing this for some time.


"Don't know the book. But people are always writing things like that. My favourite is William Rees Mogg's Great Depression of the 1990s, which never materialized (rather the reverse). Usually the predicted event doesn't happen. Sometimes it does -- though by 2010 I suspect we'll be out of this hole and Harrison's book will be out of print."

The comments above are in regards to Fred Harrison's book, Boom Bust: House Prices, Banking and the Depression of 2010, this is also a book I have read. Yet if Prof. Ferguson had done sufficient research and indeed read the book before passing judgement, he would have discovered that there is a very set pattern for the gap between each housing boom, specifically 18 years which Fred Harrison shows in his book. The book was also written in 2005, just as the housing market was slowing down and many thought it would collapse, however Fred stated that it would carry on for another two years, the period he terms as the "winners curse". He also said it would carry on with double digit rises, when everyone said it would slow to more moderate growth, as he claimed hysteria would grip the market once more. He also wrote a book back in the early eighties, The Power in the Land, in which he predicted the recession of the early nineties, so this is not a one off.

The assumption that we will be over the worst by 2010 is wrong and sounds like he has been listening to the Labour Government. This stagnation will go on for years in the West. 2009 will be even worse, with more bank failures, huge unemployment, and rising debt. Government finances will be in a hideous state and 2010 will be a grim year too, with in all probability the beginning of what will be years of inflation, as 2009 winds down.

"No, we are in a very different situation from the world in 1929, although the potential was certainly there for a Great Depression 2.0. The key difference is that the Federal Reserve System and the U.S. Treasury are doing everything in their power to combat the collapse of the banking system. And so far they've done a pretty good job. I find it hard to believe that this time next year will be so worried about deflation and depression. The conversation may even have switched to inflation and the need to reverse some of the stimulus that was injected."

The final sentence of the above comment concurs with the first statement in this article, however it is his comments regarding the authorities' interventions that I wish to tackle, as he quite clearly has a incorrect interpretation of history. As I have shown in a previous post the Great Depression was caused by government intervention, the Federal Reserve slashed interest rates from 6% to 1.2% and took all sorts of financial instruments from the banks to prop them up. Prof Ferguson seems to place a belief that they have done a good job, however President Hoover was saying exactly the same at the end of 1930. It wasn't until the second half of 1931 when things really were desperate, and the previous measures had quite clearly had no effect. Governments make the situation worse, which I will dedicate a post at a later date to fully explain why free markets should never be interfered with, even during a bust. He's right in once aspect that later in 2009 we shouldn't be worried about deflation, the monetary expansion along with the depletion of goods should ensure a resurgence in inflation again. We are facing a depression, even if the authorities never admit it, but it will be an inflationary depression.


These were just three of the comments he made in the web chat, I didn't feel the need to choose anymore comments as the post would have been too long. There were some good points regarding the Socialist Chilean President Salvador Allende from various posters and from Prof. Ferguson himself. His successor, General Pinochet was a tyrant and an oppressor of personal liberty, but Allende would not have been the Socialist Utopian alternative, as so many among the left like to believe. Before the coup, Chile was already showing signs of Totalitarianism, along with the classic hallmark of Socialist overspend resulting in the escalation in inflation. There was quite an extensive debate on this subject matter, with some emotions running high.

One of the terms coined in the series is that of "Chimerica", or the union of China and America in recent times. Ferguson paints a rosy picture of this relationship, although he does mention the possibility of a Third World War between the two without the mention of possible alliances. In one of his books "Colossus: The Rise and Fall of the American Empire", he evidently can see that America is on its way out as the worlds superpower, displaying signs of overstretch and faltering economic growth, similar to Britain's decline, decline that I suspect we will see over the coming decades (as empires always decline in over a long period of time). In the book he doesn't use the term Chimerica but acknowledges the China effect and the deficits that America is running with the rest of the world. This is one point he doesn't make an issue of in the series, which in my view is a major point. Britain, when it began its decline, was a large creditor nation with assets all over the world. America, on the other hand, is a huge debtor nation the largest in history with very little in terms of overseas assets. America, is in a far worse state than Britain was during its decline. Yet Ferguson seems to believe that America will be the main economic powerhouse for years to come. I disagree, and think he has overlooked this fact, or forgot to mention this historic parallel. The globalisation of today is far different to the one before the first world war. He mentions British trade with China, however the Chinese were very restrictive back then, only allowing European merchants to trade at key ports. They had no access to mainland China, and shifted their goods through the local merchants. In this recent revisit of Globalisation, the situation is very different. China now produces and exports huge amounts of goods to the West, and have modern economic capabilities. They are becoming self sufficient, while the West now relies on their productive facilities to make goods. This is why this time it is more experimental, as the West slowly loses its status as the economic center of the world.

In the final series Prof. Ferguson detailed the various financial events of the past two decades, from the Savings and Loans Crisis, the Asian financial crisis, the Russian Government Default, LTCM collapse, the dot com bubble, Enron then finally the housing bubble. Yet he didn't link into what caused these events, and how they kept reoccurring. Again the Federal Reserve has fostered these, and persistently distorted the market causing the major downturn we are now seeing today. All the above is created by Greenspan and Co who kept bailing the markets out. People were amazed that Lehman Brothers went bust last year, but half of those US investment banks should have gone bust 10 years ago, along with LTCM at the time. He instead pins the mistakes on human behaviour and markets. This is not true, as the market would have corrected these excesses long ago, instead the Central Banks kept bailing out everyone. In other words they took the risk out of the free market. The free market therefore did not price risk, which is a reason why the banks have so many issues we see today. This omission was fatal, as it explains the bust we are going into is not a product of the true free market, or the product of Capitalism (as many anti-capitalists have begun prophesying its downfall) but the product of Central Bank intervention. The market would have corrected all the above long before, thus we would have never had house values escalate as high as they did and an economy orientated so heavily towards these asset prices. These banks would have gone bust long before and along with it more sensible lending standards, with a more balanced economy.

After viewing the series I don't think I will be buying the book, and will probably wait until it becomes available at my local library. I was also disappointed that the series did not go into the details of fractional reserve banking, Central Banks and the artificial market forces that China have been exerting in recent years in order to grow their economy quicker. There was also a lack of history towards recent financial events, which would explain more clearly the predicament we find ourselves in. However, Prof. Ferguson is an academic, not an economist. His book Cash Nexus, another book that I have read, he declares gold as an old relic with comments such as "Gold has a future, of course, but mainly as jewelry". This was in 1999, around the bottom in Golds price, since which Gold has increased around 400%-500% in Sterling a decade since these comments. Other recent comments such as "Money is trust, not metal", is true with our modern fiat currency, however only metal ever keeps its value over history. Another historical point Prof. Ferguson misses.

Alan Greenspan, who helped cause the current issues we see, understood the damage central banks and a fiat monetary system can cause. Back in 2002 Ron Paul asked him about Gold and Economic Freedom, an essay he wrote (in which I have taken an extract from), and if he still believed it to be true and valid for today. He responded with "I wouldn't change a single word". It's a shame many mainstream commentators such as Prof. Ferguson can't see the flaws in our current system. Greenspan could.

"But prior to World War I, the banking system in the United States (and in most of the world) was based on gold and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World War I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion ... In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value."
Alan Greenspan, Gold and Economic Freedom, 1967
Note: The Federal Reserve was established in 1913

Interest Rates and Capital

“Capital as such is not evil; it is its wrong use that is evil. Capital in some form or other will always be needed.”
Mahatma Gandhi

“The highest use of capital is not to make more money, but to make money do more for the betterment of life.”
Henry Ford

"This weak republic throws its pieces of paper about wildly in order to enable its main party functionaries ... to feed at the trough"
Adolf Hitler


The use of paper money has become ubiquitous in modern times and with the introduction of computers in the past few decades, society has become accustomed to the further abstraction of money in the form of pixels, a series of 0's and 1's to represent money. We all use our nations currency either the paper or electronic form, and have complete trust and faith in what it represents and it's intrinsic value. Is this blind faith in pieces of paper justified? As we have only grown up in a society whose main medium of exchange is the use of government currency, should we place an almost religious belief that it will always retain its value? We have recently had a meeting between the G20 countries, to co-ordinate agreements towards a global fiscal stimulus package. The Bank of England cut rates by 1.5% with the base rate now at 3%. The Federal Reserve is down to 1%, with other nations Central Banks following the trend. However if we go back 6 years, weren't the low interest rates the main cause of the monetary problems we are now facing? Why do politicians always seek lower interest rates and why do we have central banks that try and impose a broad monetary policy on all financial institutions in our economy? We have become accustomed to Central Banks, almost conditioned, into the fact that their very presence is essential for a functioning modern economy. Contrary to what Central Bank are supposed to do, that is fight inflation, they are actually a huge inflationary mechanism that create the moral hazard we are now seeing and continually told about.

Central Banks are the Moral Hazard

When Mervin King the Governor of the Bank of England makes statements regarding moral hazards towards banks, its like a drug dealer giving a lecture on drug abuse to a drug addict. Central Banks amplify the effects of the boom, by flooding private banks with cheep money at the beginning of the boom. When the boom turns to bust, Central Banks begin a program of propping up private banks as the private banks always know they can turn to the Central Bank when the bust materialises. If you can't picture a modern economy without a Central Bank, then America had no central bank from the 1830's right up until 1913, just as it was becoming the industrial power of the world. The current central bank is the third America has had in its short history as a nation and is owned and controlled primarily by private banks. It was set up with the intention not in ensuring financial stability but for the purpose of increased profits for the banks, so they could load up even more with peoples debts with less need for capital. In a true free market there wouldn't be need for a Central Bank. Private banks would obtain capital and lend on their own accords. The setting of interest rates is just the supply and demand mechanism banks use in order to encourage people to either save with them, or borrow from them. If a bank has a lot of money in reserve then it lowers interest rates to increase demand for loans. If they have low reserves then they raise interest rates in order to encourage people to save and increase their capital base.

These aggressive cuts that we are witnessing bear no relation to the above supply demand dynamics detailed above. Many countries, in particular western nations, have pitiful low capital levels and huge levels of debts. What needs to be done is at least a stabilisation in interest rates, however an increase is required in order to incentivize people to save thus allowing banks to re-capitalise, capital based on human labour that has already been done. Debt is the modern Political-Monetary illusion of wealth, however its all a magic act with the money being taken from future human labour. Having a Central bank trying to set interest rates for the whole financial system is an crude instrument for influencing private institutions monetary policy, similar to the communist state planned centralised economy. It will always be inefficient.

Marx on Capitalism

Karl Marx, the most famous anti-Capitalist symbol in history, stated that sooner or later Capitalism would drown its markets in goods. It could only survive by continually cutting prices and real wages of the workers to below the point of subsistence. With markets ever expanding the Europeans would eventually branch into Asia, with ever more goods being produced but eventually the people of the world would revolt under these conditions and the global socialist system would emerge. So why has this not happened yet? One of the main flaws of a centralised state planned economy is its neglect of a suitable pricing mechanism.

The Capitalist Pricing Mechanism

Free market economics uses the basic premise of supply and demand to drive markets. This creates a pricing mechanism that is used to divert capital and labour to the required sectors of the economy in order to obtain economic efficiency. I'm not saying that capitalism is a fine tuned, super efficient economic model, far from it, I'm sure there is some economic model that has yet to be invented that is far more socially responsible. However for this reason a free market, operating under the direction of individuals and capital obtained from labour that has already been performed, induces a system of great productivity and material gains. This whole system relies on no monopoly and no centralised institution controlling a specific sector. Central Banks are a monopoly that prevent these very market forces. They prevent capital being used wisely and labour being re-deployed and used efficiently. Interest rates should always be driven by private institutions all in competition with one another, all responsible for their business actions, with no inflationary engine waiting in the background to bail them out or other businesses for their irresponsible decisions. Accountability has all but been ignored within finance recently as the bonuses were rewarded for short term decisions that were never beneficial to the bank and society.

Without a sufficient pricing mechanism Eastern Europe's Communist block collapsed as the planned state economy could not allocate resources efficiently. After the early illusionary productive gains obtained under the Stalinist Regime with the use of forced labour (the infamous Gulag camps) the economy began to collapse. The 1980's saw Mikhail Gorbachev introduce Perestroika, a policy to try and introduce a more efficient pricing mechanism, however it was too late as inflation and product shortages had become widespread.

The Capital of Asia

The IMF have recently begun to show the strain and how little capital they have. A world body that is supposed to ensure stability and provide capital for nations in need of it has now begun turning to the Japanese for money. They are increasingly seeking funds not from Western nations, but from Asian Nation states. The reality of the current situation in the global economy is the G7 and the IMF have very little capital. The real countries that hold the capital are now in Asia. An assumption that the West are the rich is simply not true the way things stand. Asian countries with savings rates of anything between 20% and 40% are now the people with capital, the west with negative savings rates are the ones who are now in poverty, relying on the external capital flows from Asia. It's only our high levels of debt, our old infrastructure that gives the illusion of wealth. Why do you think people were given 125% mortgages? Why do you think everything was on credit with no one saving? Why did you think people could buy a whole street of houses, with no money down, just the supposed capital gains of previous acquisitions? It wasn't because we had entered a new frontier of Western superiority. Asians were giving us their Capital. Capital that they obtained by expending human effort to produce goods for us to consume. They gave us more capital so that we could continue loading up with more debt and buy more goods from them and they further increased their capital reserves, buying bigger stakes in our economies. Now the global downturn has come, Asian economies are being hit more and more, and this 'agreement' above is beginning to break down. Capital, instead of going West is now in retreat back to China or Japan. This is what happens when you rely too much on foreign capital to fund your consumption. This is why in particular the US and the UK need savings. Tomorrow always comes and with it real problems.

Sterling Collapse?

One such country who was greatly reliant on external capital was Britain. It tapped foreigners for their capital and used London as the driver for this financial utopia. Britain has the second largest external liabilities behind the US. Recently the Shadow Chancellor George Osbourne has come out and said a future sterling collapse could occur due to the unfunded borrowing of the Labour government. What became interesting was the reaction his comments evoked. Rather than dismiss it, opposition politicians have labelled it as "irresponsible" or "dangerous". I thought our politicians were supposed to challenge and offer conflicting views. If there is a run on the pound, there will be a run on the pound not because of what one man said, but because of fundamentals relating to the UK economy. If they continue with inflationary policies, deficits continue rising with little internal savings as foreigners sell their pounds then a run seems likely.

Helicopter Ben

Ben Bernanke the current Chairman of Americas Central Bank has dedicated an academic life to the study on the causes of the Great Depression. Two of his economic heroes are Milton Friedman and the latters wife, Anna Schwartz, who some four decades ago co-authored a landmark book entitled "A Monetary History of the United States", on which he based a lot of his ideas regarding the Great Depression. In a recent interview that Anna Schwartz gave she said Ben Bernanke was getting Fed policy wrong and the problem does not lie with liquidity or money supply. It lies with the toxic securities that Wall Street has created. Her comments regarding these were,

"Because you cannot sell them, you don't know what they're worth, your balance sheet is not credible, and the whole market seizes up."

She went on and said that Paulson and Bernanke have now prolonged the crisis,

"They should not be recapitalizing firms that should be shut down ... Firms that made wrong decisions should fail."

Central Banks are just a monopoly, and just like any other monopoly are desperately inefficient. They create huge distortions during the boom and prolong the bust, punishing the prudent among us and propping up institutions that should be liquidated to create a more efficient economy. Capitalism's "Creative Destruction" has been replaced with "Monetary Creation". He still believes we had the Great Depression because the Central Bank didn't print enough money. The reason we had the Great Depression are the reasons given in the quotes above.

Weimar Germany

"I do not believe a word of the silly stories that the German Government could be so bold or so mad as to engineer on purpose what will in the end be a great catastrophe for their own people."

The most recent example in modern Western history of a nation experiencing serious inflation and its destructive effects was Weimar Germany just after the First World War. After incurring substantial debts during the war and the imposition of further debts by the victor nations, the Reichbank pursued inflationary policies through persistent trade and budget deficits and the increase of government spending. All the European countries incurred substantial debts during the First World War, Britain had debts amounting to 136% of GDP but Britain avoided hyperinflation. Inflation was high, running at around 22% but nothing like Germany which witnessed people wheelbarrowing worthless Marks to burn as a source of fuel. The currency was destroyed by irresponsible fiscal and monetary policies, Britain chose debt service, while Germany ramped up the printing presses. Just before hyperinflation became evident Germany experienced deflation, with inflation dropping to 2% with the Mark rallying, just before its spectacular collapse. I warned in one of my previous posts that the media and institutions would begin warning about the misconceived notion of the dangers of deflation, and we are beginning to hear more about it with Gordon Brown now mentioning it. Deflation is a natural function of a free market. We are not going to get a true deflationary bust that would happen in a truly free market as governments and Central Banks are now pursuing inflationist policies similar to the above, with economies that ill equipped to weather the storm.

One of the main causes for the rise of National Socialism and Adolf Hitler was the hyperinflation caused by Weimar Republic contrary to the conventional emphasis placed towards anti-semitism and First World War grievances. It destroyed peoples savings, capital that people had laboured for their whole life vanished in a matter of months. Whether any Western nation will experience hyperinflation remains to be seen and one hopes not, but as economies shrink, debt increases, trade collapses, deficits rise and more people claim benefits, we have the conditions for at best, mild inflation.

The quote given above is a comment made by economist John Maynard Keynes in November 1921, who was an advisor and influential figure towards German economic policy during those fateful post war years. A person whose inflationary economic theories have become biblical in recent decades.

The Last Bubble?

Western Government Bonds are shaping up to be the next bubble in a very long line of bubbles, from the Dot Com Stock Market bubble, to the Real Estate bubble now government debt is beginning its exponential climb upwards. However if this does become a bubble and bursts, its effects will be felt very quickly and violently in the nations it occurs in. If there are no buyers for government debt, then interest rate will have to rise in order to attract capital, how high it all depends on if investors think the government is solvent. For years the US has abused the Dollars status of world reserve currency, building up many enemies throughout the world through its Imperialist policies. From the teachings of Sun Tzu in China, to the chess culture of Russia, they are all waiting for their opponent to self destruct or make continued mistakes.

A Sound Currency

Money is not a new concept, it has been around for millennium used as a means of exchange between people, a store of human labour or something people value. Empires have come and gone along with currencies too, but there is one that has withstood the test of time. Gold. In our modern western culture it has been associated with extravagance with no intrinsic value, however when we step outside our conditioned frame of mind that has been shaped by the environment we have grown up in it becomes something different. If you took an ounce of gold a thousand years ago, to an ounce of gold now its purchasing power would be more or less the same. Gold is a rare metal that can't be printed out of thin air like banknotes can. That's why it has always held its value throughout time, throughout the world. Older generations always remark that a penny today isn't worth what it was 50 years ago, however people don't seem to realise that this is due to the inflationist policies of the people who regulate our currencies. The reason why we have more money then we did at any other time in history, is not due to the fact that everyone has become richer, its because more of it has been printed. This is why we always experience inflationary periods throughout life, market forces are always deflationary as economic efficiencies are made from capital that is re-invested. Its politically popular to increase the money supply, to give a short term illusion of wealth or to try and pay off excessive debts. People make statements asking why value is placed in an archaic metal such as Gold or Silver, but never ask the right question, why a set value is placed in a piece of paper with pictures on it. History has always shown precious metals to uphold their value as a store of human labour. All modern fiat currencies have shown persistent devaluation over time, especially when debt is as high as now.

Will it Work?

The favourite phrase in the media over the past year has been "Will it Work?". New policies are implemented with the same question repeated over and over again, now with interest rates falling we are told this is the latest silver bullet. The real question should be what are we trying to solve? The Credit Crunch isn't the problem, its the cure. Its brought about an end to reckless lending, a recapitalisation of banks, a break on consumption, the re-balancing of the economy, yet "remedies" to the credit crunch are formulated as though it is the problem. The patient is sick and just as the doctor was about to administer the medicine the "I know better" parent with no medical training stepped in to provide the "real cure". By delaying the treatment the patient becomes worse, until eventually the patient is no longer ill but becomes terminally ill, beyond help. The pricing mechanism for capital has been distorted by the Central Banks and Governments. The end result could be disaster for nations with little or no capital.

Credit Crunch Part II and Beyond

"At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."
Fed chairman, Ben Bernanke, Congressional testimony, March, 2007

“When written in Chinese, the word "crisis" is composed of two characters-one represents danger, and the other represents opportunity.”
John Fitzgerald Kennedy, 35th US President

When the credit crunch began last year a lot of people didn't seem to realise the severity of what was happening. People saw stock markets fall and massive liquidity injections, and thought it wouldn't effect them. As soon as I heard the news and saw the footage, I knew this was the beginning of something, a once in a life time experience. The financial institutions realised the music had stopped and now came the consequences of decades of monetary expansion. The Credit Crunch is just the beginning of the start of something much worse. To use an analogy of a car crash, the credit crunch was just the person seeing what was coming and putting the brakes on. The real pain is yet to come.

We are entering the next stage of the crises, Credit Crunch Part II. Central banks have been busily infusing huge amounts of money into the private banks, through the swapping of Treasuries for the banks alphabet soup of deadly cocktails of debt. At what point will Central Banks stop? There has to be a limit, I mean they are effectively taking over the market, a market which is massive. This is the juncture we are at, where the Central Banks will soon begin to slow the liquidity they provide and start getting a lot more selective. British banks have been issued huge amounts of money, and not just from the Bank of England, but from the FED and the ECB due the global connectivity of banks. British Banks are in fact in a terrible state, which doesn't surprise me as I warned the economy was too reliant on finance. This is the part in the chapter where lending begins to get a whole lot tighter.

The media continually report that all these liquidity schemes will soon have banks lending back to the recent decade of reckless standards, however this will not be the case for decades. Libor is still showing great signs of stress, and will continue to do so. We are entering the phase where job losses will really start picking up, losses will keep increasing on debt, governments deficits and debt will keep going up. Worldwide currencies are fluctuating everywhere, the price of gold will begin to rise over the coming years. Incomes are being squeezed. Credit Crunch Part II will be much worse than last year and I can see major problems in the system in October, and definitely once the next president is in office at which point the recent rally in the dollar should resume its decline. Its the beginning of the impact in the car crash analogy, a realisation of the trauma and pain to come.

Looking beyond Credit Crunch part II the next decade will be completely different to now. Prices of stocks and property won't reach their 2007 highs until at the earliest around 2022 (unless hyperinflation occurs at which point you won't care what those are worth). This is a huge leveraged boom and the fallout will be very severe, for the world. Old powers will slowly collapse from within, and new powers will rise and replace those who have lost principles of thrift. Currencies will collapse and be replaced by new ones or nations will converge into single currencies. Present future liabilities will be realised as those future debts will now become a reality, staring my generation in the face. Industry will change, to quote,

"During the great bear market in commodities that began in the 1980s and carried into this decade, very few college entrants dreamed of becoming engineers and geologists to work in the commodity sector, but instead poured into finance and technology related degrees. This has created a vacuum in available talent that will only get worse with the retirement of many existing engineers and geologists that received their degrees in the last commodity bull market of the 1970s."

My father is included in the above description, and as global energy and commodities demand increases in the future he may even come out of his coming retirement to take part in the greatest boom since he started in the industry.

It will be an interesting time to live in and I personally can't know for certain the outcome. All I do know is that at this present time, with the facts as they stand, a similar future as described above seems very likely.