(This is Part 4 of a series. Go back to Part 3.)
Virtually every government in history that has been faced with overwhelming debt has chosen the third option and begun a systematic inflation of the money supply, leading eventually and inevitably to a raging price inflation.
This was true of Britain in the 1710s, France in the 1790s, the U.S. Continental government in the 1770s, Germany in the 1920s, Hungary in the 1940s, China in the 1950s, Brazil in the 1980s, Argentina in the 1990s and so on.
Money and credit inflation is a very pleasant phenomenon at first, particularly for the governments involved. It just seems like such a painless solution to the pressing debt problem. No new taxes need be enacted and no serious spending cuts need be made.
In fact, inflation is like a secret tax levied upon consumers and businesses. The tax comes in the form of lowering the purchasing power of the currency held and used by the populace. Since not one citizen in a thousand understands that this is a hidden tax, the government can claim to be "holding down taxes".
As its debt gets monetized the government gets to float yet more debt and spend yet more money that it didn't have before. As new liquidity flows through the system, the economy picks up. All very pleasant.
The huge costs come later as the process turns malignant. Prices and interest rates eventually begin a relentless rise and the unit of currency becomes increasingly debased. Continued to its ultimate conclusion, the process winds up impoverishing the populace by destroying the store of value in the currency.
The process can be stopped at any time if the government stops creating new money. However, the effect of this is to immediately precipitate the economy into a recession or worse as artificial stimulation leaves the system. This is politically unpalatable, and so what normally happens is that the government creates yet more liquidity to prop up the system yet again.
We can cite the United States as an example. Since 1987, under Chairman Greenspan, the U.S. Federal Reserve has responded to every hint of an implosion in the economy by flooding the system with liquidity.
It happened in the 1987 stock market decline, the 1989 savings and loan debacle, the 1994 Mexican peso crisis, the 1997-98 Asian Tiger devaluations and the 1998 failure of Long Term Capital Management, which created a $90 billion crater from radioactive credit.
In each case, because the overall credit bubble already existed, the "triggering event" could have precipitated an implosion of the bubble and a recession. Such a course would have been constructive, but it was not to be. In each case, the added liquidity jolted the system forward once again while increasing the size of the credit bubble.
The magnum opus of this process, surely, has been the reflation following the 2000-2002 stock market decline. The creation of liquidity this time has truly been on a biblical scale, resulting in a reflation of the stock market and huge increases in the bond and real estate bubbles.
This reflation in money and credit by the U.S. has been mimicked worldwide, with the result that the world has now created the largest global credit bubble—measured
as a percentage of global GDP—ever conceived.
The question now becomes: What will happen when the next "triggering event" occurs?
(This is the end of Part 4. Go to Part 5.)
—jim sloman, 03.06.05
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