The Incomparable Faith of Keynesian Investors
Tea Party Economist
by Gary North: Why
the Deflationists' Argument Is Wrong in Both Theory and Historical
I read something in the mainstream financial media whose degree
of delusion takes my breath away. This
is such a sentence (August 2, 2012).
stock index futures pointed to a higher open on Wall Street on Thursday,
with investors hoping the European Central Bank will signal further
measures to aid growth and prevent the euro zone collapsing.
This was published
by CNBC, a cable TV network that remains perpetually bullish. It
was posted no later than 6 a.m.
to aid growth: check.
eurozone from collapsing: check.
another avoidance of the collapse of the eurozone."
A collapse of the eurozone. Is that right? There might be a collapse
of the eurozone?
And the ECB
may do something to prevent this? Possibly?
American stock futures are up. Have I got this right?
Am I to assume
that if the ECB fails to take action, that the eurozone could collapse?
Am I also
to assume that, tomorrow or next week at the latest, American stock
futures would then be down?
We are expected
to believe that a collapse of the eurozone is possible. This might
mean the destruction of the euro, which would fall to zero value.
What could cause that? ECB inflation. This is scenario #1.
On the other
hand, there is scenario #2: the collapse of the eurozone might mean
the departure of Spain, Italy, and France, which would cease paying
euros on their IOUs. That would mean huge losses for commercial
banks in every nation, and huge losses for the ECB, which is loaded
with these IOUs.
What can prevent
the latter? The former. To keep the governments of Spain and Italy
solvent, meaning able to make regular interest payments on their
IOUs, the ECB must buy their IOUs with newly created euros.
authors of the article implied, and investors seem to believe, that
there is a middle path between scenario #1 and scenario #2. So,
when Draghi made his unofficial remarks at a pre-Olympic dinner
party for the swells, stock market investors grew briefly optimistic.
They placed their orders.
The word "collapse"
implies a breakdown. It means a major discontinuity. In this case,
it means a breakdown in exchanges of euros for goods and services
on the continent of Western Europe. It also means the overturning
of 15 years of official assurances.
it means a major crisis.
We have now
entered the era of official reassurances. The assurances are long
is in a permanent state of crisis. It is not going to get out of
this crisis anytime soon. The Greek government may pull out of the
eurozone this year. This would be good for the eurozone. That morally
bankrupt government should never have been allowed to join.
As for Spain
and Italy, they may also depart sometime in the next 12 months.
What will keep them in is ECB inflation. The ECB will create digital
euros and buy the IOUs from these two economically bankrupt nations.
If the ECB
can persuade Angela Merkel to persuade the German parliament to
fork over a few hundred billion extra euros to keep the governments
of Italy and Spain from defaulting on the debts they cannot otherwise
pay, the day of reckoning can be delayed.
If Italy and
Spain default, this will take down many French banks. If the ECB
refuses to bail out France, which will in turn bail out large French
banks, France will leave the eurozone and restore to its central
bank the right to create fiat money.
leave Germany, Finland, the Netherlands, and 10 other nations to
keep the euro alive.
then probably go back to the Bundesbank and the deutschmark. Why
stay in a shrunken eurozone?
All this will
take time. It will be accompanied by assurances from inside eurozone
senior circles that none of this is really happening, that the eurozone
will remain intact, and that rumors to the contrary are exaggerated.
depart, representatives of those nations that still remain will
say that the recent departure of the others was an aberration. "Nothing
to it. Trust us."
formerly of Goldman Sachs and presently the head of the ECB, assured
guests at a pre-Olympics gathering of high officials that the ECB
will do whatever it takes to hold the eurozone together. That was
Wednesday evening. That off-the-cuff remark mobilized investors
on Thursday, which pushed up world stock markets. No one asked Draghi
what he had in mind that was new. No one asked to hear a summary
of his new plan. The other plans had been vague. He has no new plan.
He has one vote on the board of an institution that can legally
create money out of nothing and buy IOUs with it.
So, it is
up to Merkel and Draghi to work out a plan to unify the 17-member
eurozone into a national government with a common fiscal program.
Here is the
bone of contention. Draghi wants a unified government whose IOUs
are issued by all 17 members. This means that Germany and the Netherlands
must co-sign the notes issued by the central government. Merkel
says she will never consent to this. She has repeatedly made assurances
like this. But she has broken them whenever the banking system looked
government-guaranteed bonds with the full faith and credit of the
eurozone. This means bonds will be issued with the full faith and
credit of Germany. Germany is the paymaster. It always is. Like
a rich uncle, Germany attracts ne'er-do-well cousins, who want to
be put on the lifetime dole by Germany. They want to borrow from
German banks and the German government. They want to avoid paying
back principal, which they cannot do apart from hyperinflation.
They want ever-larger cuts in interest rates and ever-larger welfare
state spending. Aunt Angela is expected to fork over the money.
had anything new to offer, he did not explain what it is. He has
had a week to do so.
up sharply the day after his remark, and they did not fall back
for a week. This indicates that the investing world believed that
he has a new plan, despite the absence of any evidence. They believed
that the great discontinuity the collapse of the euro can
and will be overcome by means of Draghi's plan.
does the ECB have? The power of money creation. There is no question
that the ECB has this power. Just ask Angela Merkel. The ability
of the ECB to inflate is the bone of contention between Merkel and
of the comparatively solvent northern nations, which have export-driven
economies, favor large trade surpluses. They are upset that the
borrowers have borrowed far more than they can repay. Everyone knew
that when the loans were made. There is never permanent repayment
in a Keynesian, fractionally reserved universe.
debt cannot be paid back without a 99% contraction of the money
supply (with a 1% reserve ratio). The central banks must replace
paid-off debts with new ones. This is the ultimate lobster trap
of debt. All central bankers have known this ever since at least
1900. Central banks' purchases of debt create the ultimate economic
addiction. The investors believe that this will not happen. They
believe that there will be no contraction of the money supply. If
there were, this would create a replay of the Great Depression's
first phase, 1930-33. Then it would further contract. Most banks
would fail. Almost all IOUs would become worthless. No one could
repay. That was why Congress created the FDIC in 1934: to stop the
runs on banks, and therefore to stop the contraction of the money
So, the investors
believe that the ECB, the Federal Reserve, the Bank of Japan, the
People's Bank of China, and all other central banks will take action,
meaning money creation, to prevent any such scenario. But they also
believe that there will not be hyperinflation. They believe in a
middle path between hyperinflation and Great Depression 2.
So do central
bankers. They believe that they can always avoid the two worst extremes.
But the only factor preventing hyperinflation today is the unwillingness
of commercial banks to lend the Western central banks' post-2007
monetary bases into circulation, multiplying through the banking
could change. The central banks could make it change overnight by
imposing fees on excess reserves held at the central banks. There
would be a huge economic boom in commodities, but the price of this
boom would be runaway consumer prices. That would be proof of defeat
for central banks.
2, an hour before the U.S. stock markets opened, he gave a brief
speech. He said that the ECB has no fixed plan. This had been the
universal assessment of his critics for a week. His comment a week
before had been rhetorical, not substantive.
Until he gave
that speech, stock markets across Europe were up. Then they all
dropped like a stone: straight down. It was as if they had fallen
off a cliff. This was at 9 a.m.
American stock futures reversed. The note of optimism that had marked
the CNBC story at 6 a.m. was gone. Thirty minutes after Draghi's
speech, the Dow Jones Industrial Average opened down over 130 points:
All of this
intra-day trading is neither here nor there in the grand sweep of
events. But what happened within just a few minutes indicates the
extent of unwarranted faith in Draghi's words.
is headed for many years of trouble, irrespective of Mr. Draghi's
remarks. The ECB is trapped. It dares not inflate to the degree
that Germany will pull out of the eurozone. Yet it dares not stabilize
the money supply and refuse to buy the bonds issued by PIIGS. It
must walk down that middle path.
would respond in wild enthusiasm for one day to an off-the-cuff
remarks by Draghi at a gathering of Big Shots indicates the utter
credulity of investors.
That any article
writer could believe that the euro is headed for a collapse, as
distinguished from a slow decline of purchasing power in relation
to foreign currencies, indicates that they do not understand monetary
policy, nor do they think their readers do.
investors or journalists could believe that anything Draghi says
is economically significant indicates the extent to which the world's
capitalists and their salaried cheerleaders in the media have faith
in central bank monetary inflation. What possible new idea could
Draghi have brought to the table on the day the Olympics opened?
What had he cleared with other senior members of the ECB? Nothing,
as they said before the one-day boom in stocks was over. He had
not discussed anything with them.
But what if
he had? What if they had all agreed to make an announcement to the
media, rather than to a group of famous party attendees? What difference
would their announcement have made? None. A committee's announcement
is filled with qualifications and hedges. This is why committees
do not get invited to swank dinner parties thrown by senior politicians.
wild men don't get invited, either. Peter Schiff is not invited.
I'm not invited. Surely Gerald Celente is not invited. Big Shots
are afraid of loose cannons as much as they are bored by committee
CENTER DOES NOT HOLD
system grinds on. So do the capital markets. There is no collapse.
But at some
point, the ECB senior committee and the Federal Open Market Committee
composed of regional central bankers will have to fish or cut bait.
They will have to inflate in order to keep the system moving upward
rather than down the way it did in 1930-33 and again in 2008. They
do not dare let the largest banks go under.
said the ECB would do whatever it takes to save the eurozone, he
had in mind big banks. This is what every central banker has in
that the politicians will fall in line. They always have before.
He does not think times have changed.
But to move
in the direction Draghi says is imperative means fiscal union imposed
by frightened members of European national parliaments. He does
not think for a moment that the voters should be allowed to decide
this, for there will be more than one nation whose voters decide
against fiscal union. The creation of a 17-member eurozone with
power over each nation's budget will not be imposed by another treaty.
It will be imposed by political fiat, a fiat that will be matched
by central bank fiat money.
Can it hold?
Can the elected legislators who impose this system retain their
offices and thereby head off secession? I don't think so.
just another former Goldman Sachs agent. He is whistling past the
What is that
graveyard? The graveyard designed almost a century ago by the consummate
globalist of modern times, Jean Monnet. He is widely acknowledged
as the designer of the New Europe.
1955, Monnet founded the Action Committee for the United States
of Europe in order to revive European construction following the
failure of the European Defense Community (EDC). It brought political
parties and European trade unions together to become a driving force
behind the initiatives which laid the foundation for the European
Union as it eventually emerged: first the European Economic Community
(EEC) (1958) (known commonly as the "Common Market"), which was
established by the Treaty of Rome of 1957; later the European Community
(1967) with its corresponding bodies, the European Commission and
the European Council of Ministers, British membership in the Community
(1973), the European Council (1974), the European Monetary System
(1979), and the European Parliament (1979). This process reflected
Monnet's belief in a gradualist approach for constructing European
adds this: "On 6 December 1963, Monnet was presented with the Presidential
Medal of Freedom, with Special Distinction, by President Lyndon
Johnson." This was 13 days after Johnson had become President. If
you don't think this indicates the enormous power of Monnet, you
do not understand Presidents' calendars.
The ECB is
an extension of his power, a generation after his death. So is the
European Union. So is the eurozone. Will they collapse? No. Will
they slowly disintegrate? Yes. Why? Because the dream of political
centralization in our day is the dream of central planning in every
area of economic life. Central economic planning always produces
deny this. Keynesian investors put their money where their faith
is. They are going to lose most of their money.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 31-volume series, An
Economic Commentary on the Bible.
2012 Gary North
Best of Gary North