The future of the present monetary system, or the future of money as we know it today, is a very hot topic, especially if we look at actions of the most important central banks all over the globe. Their present actions are consequences of the so-called financial crisis, which was caused by a very easy monetary policy. So, first of all, we have to ask ourselves if the current crisis is (especially in Europe) in a process of resolving itself or developing and why so. The current crisis is not a normal business cycle. It is a global depression caused by the collapse of asset bubbles, deleveraging, excessive debt and regime uncertainty due to a lack of clarity of public policy on such matters as taxes, regulation and labor. This is true of Europe, Japan, China and the U.S., although the U.S. is the main problem, because Federal Reserve’s easy money policy from 2002 to 2007 was the leading cause of the problem in the first place, and U.S. policy on taxes, health care, etc. is the most difficult to discern.
A depression is caused by structural problems and, therefore, it can only be reversed with structural solutions. Unfortunately, most governments are not using structural solutions; they are using cyclical solutions, such as greater monetary easing. These cyclical, liquidity-based solutions will not work because they do not address the problem. This analysis applies to the U.S., China and Japan. Europe is somewhat of an exception here. It is the only major economic area that is making the much needed structural adjustments. The past four years in Europe have been difficult, however, significant progress has been made and positive results are beginning to emerge. European unit labor costs are now globally competitive, labor mobility is improving, bank regulation and prudential measures are being put in place, fiscal reform is advancing and the Euro currency is strong and getting even stronger. China, the U.S. and Japan have made far less progress than Europe, so they will suffer more in the future.
As we can see, the Fed and other central banks decided to handle the crisis using the so-called QEs. The Fed did not taper in September and, in my opinion, they will not taper at all before Ben Bernanke leaves as Fed Chairman next January. The tapering decision depends on economic data. If the data continues to be weak, which is probable, the Fed will not taper. If the data appears much stronger, the Fed may taper. However, the underlying economy in the U.S. is weak regardless of temporarily positive data. If the Fed does taper, they will be tapering into weakness and will have to reverse the course and increase asset purchases sometime in 2014. With or without tapering, monetary easing will continue and is likely to continue right up until the next liquidity crisis and financial panic. The reason why monetary easing will not work is because it is a cyclical, liquidity solution to what is a structural problem. Only structural solutions will solve the problem and we don’t see any structural solutions being implemented except in Europe.
We have to realize that the Fed is unable to stop the policy of QE, because it does not work and the economy is not moving toward a self-sustaining recovery. On the other hand, QE does inflate asset bubbles in stocks and housing, and if the Fed removes monetary easing, those bubbles will collapse and put the economy back into a steep recession. So, the Fed has no good options. It must continue the failed policy, to the point of collapse, in order to avoid a steep recession in the meantime.
Do we see any collapse of our present monetary system then? First of all, the QE does nothing to create real wealth and real growth. All that it can do is inflate asset bubbles and cause nominal growth through inflation. The Fed hopes that nominal growth will translate into real growth, but there is no transmission mechanism for this to occur. In a fiat based currency system, such as the world has today, the system rests on confidence. Next time the asset bubbles collapse, confidence will be destroyed for the last time and the system as a whole will collapse.
So, the question is not if, but when. From my point of view, the collapse will likely commence in 2015 or 2016. Asset bubbles are being inflated now, but they can continue to grow longer than many people expect, so the collapse is not likely to happen next year, but is moving closer by the day. The cause of the collapse is unimportant and probably will never be identified precisely. What is important is the instability of the system as a whole. When an avalanche happens, it is more accurate to blame the instability of the snow pack than the action of a single snowflake that started it. The snowflake is unimportant. What matters is the unstable state of the system.
Finally, let’s look at the Euro perspective. In practice, a collapse of the monetary system – really a collapse of confidence in the system – does not mean the end of the world; it simply means that the major economic and trading powers will come together to reform the system and write new “rules of the game.” These rules are likely to include a much reduced role of U.S. dollars and an increased role of the IMF world money, called the special drawing right, or SDR, and possibly gold. Slovakia will be part of the European delegation in this process, led by Germany, the ECB and the EU. This is good news because the members of the Euro area have over 10,000 tons of gold, compared to 8,000 tons in the U.S. and about 4,000 tons in China, so Europe will have a leading voice in the shaping of the new system, and Slovakia will benefit from its association with the EU and the Euro. However, one result that can be expected worldwide is inflation.
A collapse of confidence in the international monetary system is likely to cause worldwide inflation, but Europe will be better off than other economic zones, because it has a stronger currency and more gold. The Eurozone economy is larger and has a larger population than the U.S. Once the dollar is no longer the global reserve currency, Europe will be in a position to have a stronger voice in the structure and operation of the future system. This will include issuance of Euro bonds backed by the credit of the Eurozone as a whole, not just by individual countries. It will also include unified banking regulation and bank deposit insurance for the Eurozone. Europe could be a leader in a new system, linked to gold, with price stability, after an initial period of global hyperinflation.
James Rickards
Edits: Jakub Mendel (hnonline.sk) and Matúš Pošvanc (hayek.sk)
