How, Exactly, The World Ends

03/19/2015 10:20

by Bill Bonner

Today, I’m going to tell you about the end of the world. Not the end of the world exactly. But the end of the fiat money system President Nixon gave birth to in 1971… when he cut the dollar loose from gold. And it may feel like the end of the world, because of the social chaos it will provoke. What follows is taken from a speech I gave at Doug Casey’s La Estancia de Cafayate

I’ve been predicting the end of the world – at least the end of the post-1971 monetary world – for a long time.

I hope I’m wrong about it. But sooner or later, I’ll be right.

In the meantime, I’m like a surgeon who has just botched an operation. He sees the patient stiff on the table and wonders if he should go back to the textbooks. Maybe the anklebone is not connected to the shin bone after all.

But the textbooks are hopeless. They’re written by modern economists. And they believe an economy is mechanistic, not humanistic.

These folks have fixes for every problem and wrenches in both hands. They also run our central banks. And they think they know what is going on… and what they’re going to do about it.

So they give you “forward guidance.” But it is worthless. Worse than worthless, it suggests knowledge and foresight – neither of which the authorities possess.

Do you remember the Fed giving us “forward guidance” before the crisis of 2008?

You can’t solve a debt problem with more debt. That’s what the Fed is offering.

I don’t.

Neither Ben Bernanke nor Janet Yellen had any idea what was happening. They couldn’t give any forward guidance about that crisis and can’t give any about the next one.

They just react to events. They neither see them coming nor control them. And they have only one major reaction – even more credit.

But you can’t solve a debt problem with more debt. That’s what the Fed is offering. And that is what the European Central Bank and the Bank of Japan are offering too.

They are committed to this policy of providing more and more credit to a world that is already drowning in it. I should stop here and say a few words about how the economy really works.

These clumsy mechanics at the Fed, the European Central Bank and the Bank of Japan think they can turn knobs and adjust levers. But an economy is a complex dynamic system with intricate feedback loops.

It responds to the ham-fisted grease monkeys at central banks, but not necessarily the way the feds want. It is far more complex than they can ever understand, let alone control.

Right now, they are getting away with jaw-dropping policies. The markets are not yet punishing them. In fact, investors seem to be rewarding this kind of innovation.

For example, what is 1.1% yield on a Spanish 10-year government note if not an invitation for trouble? Or how about a 10-year German government note with a yield of 0.2%?
Europe’s governments are deeply in debt. And the ECB is now making it easier for them to go further into debt.

It’s impossible to know what will happen exactly. But someone is going to lose money. These yields are unnatural. And downright dangerous.

But the risk is not just that the pace of consumer prices will outstrip these puny yields; it is also that bond issuers will default.

Europe’s governments are deeply in debt. And the ECB is now making it easier for them to go further into debt.

Europe’s bond yields are at their lowest level in 150 years. About one-third of the total new issuance carries a negative nominal yield (that is before you account for inflation).

What sense does it make for the ECB to drive yields lower still… by further pushing up prices? (Bond prices, remember, move in the opposite direction of yields.)

None at all – except that many European governments and corporations now get paid to borrow money!

And the clever Japanese have another trick up their sleeves. Not only is the BoJ directly propping up the market for Japanese government bonds. It’s doing the same with the stock market. Our head spins. But it’s true.

When it comes to overdoing it, nobody overdoes it better than the Japanese. Remember, near the close of World War II, when Japanese pilots strapped themselves to flying bombs? The Bank of Japan is set to buy $1.4 trillion of government bonds under its current QE program.

Kamikazes took to the air hoping to die in a fiery explosion on the deck of a US aircraft carrier. Today, it’s Japan’s monetary policies that are kamikaze. The Bank of Japan is set to buy $1.4 trillion of government bonds under its current QE program. This allows the Japanese government to continue going deeper and deeper into debt.

But the BoJ has more explosives to strap onto its financial kamikazes. Why stop at buying bonds? Why not buy stocks too?

The BoJ has been a buyer of Japanese equity exchange-traded funds (ETFs) since 2010. And in September 2014, it bought a record amount of stock through its ETF-buying program. This makes it the single largest holder of Japanese stocks in the world – with 1.5% of total capitalization.

The BoJ chooses to buy the dips too.

I doubt this is because BoJ governor Haruhiko Kuroda is a value hunter. Instead, it is almost certainly because he wants to manipulate stock prices directly, just as he does with the bond market.

The BoJ has waded into the stock market one in every three days since 2010, reports the Wall Street Journal.

Where does this lead? To a fiery crash!

As Yogi Berra would say, America is going to come to a fork in the road… and it’s going to take it.

Obviously, that won’t work forever. I don’t care how many knobs you turn or how many levers you pull. It doesn’t work that way. Ultimately, you’re putting rusty nails on the ground… and you’re going to step on them.

How? When?  Nobody knows. But I’m going to take a guess…

And here I’m no longer using my powers of observation to tell you what is going on. I’m using my intuition and guessing. The weakest link in the central bank chain, I believe, is credit. So let’s look at how this link might break. In our modern economy, when we talk about “money” what we are really talking about is credit.

Banks create this credit ex nihilo (out of nothing) when they make a loan. It exists, for the most part, as a digital record on a computer network somewhere…And unlike even traditional paper money, this credit can vanish as quickly and easily as it got here in the first place. Because it is purely digital in nature, you can’t hoard credit. You can’t put it in your safe. You can’t take a wheelbarrow full of it to the grocery store for a loaf of bread.

Credit depends on trust. (The word “credit” comes from the Latin “credere” – to believe or trust.)

So, when our financial system implodes – which is what always happens when there is too much debt – the machinery of borrowing and lending will seize up. No one will trust that he will get paid. Credit will simply disappear – trillions of dollars of it – overnight.

This is, of course, not the end of the world. Nor even the beginning of the end. But it will be the end of the beginning of the paper money world President Nixon unwittingly created in 1971.

Then the end can begin…