USA Melts Down

Something very similar happened in USA in 2006. In 2001-2002 the USA went through the dot-com crash (yet another bubble) and a recession followed. In order to “stimulate” the market, the USA CB printed, printed and then printed some more (i.e. lowered Interest Rates to ludicrous levels) and kept it there for a very long time. The CB lowered Interest Rates to 1% disregarding all lessons learned from Japan, who lowered to “only” 2.5% and caused their market meltdown.

In addition and just to make sure that the screw-up would be gigantic, they left those interest rates at that level between 2001 and 2004, longer than Japan did. With all that cheap credit available and lower profits, Banks decided to increase the volume of loans. And so, if you were live enough to fog a mirror, you could get a gigantic loan which you could then spend in all kinds of speculations, particularly houses and securities.

In the year 2004, the USA CB realized that they screwed-up, decided to “do something” about it. What they did is to raise Interest Rates from 1% to 5.35% between 2004 and 2006, hence creating a major crash in all Banks and markets simultaneously!

Then, of course and just as it happened in Japan 20+ years ago, the USA CB realizing that they had screwed-up decided to “do something” about it. What did they do? Simple, they printed, printed and printed some more.  Exactly the same as Japan did. And so now there is a tsunami of dead USA Banks, and their very own “zombie banks”, but this time is USA-style.

Since 2006 the USA economy has been going nowhere fast. Interest Rates are now at 0.1%, exactly as in Japan, and there are no prospects for any improvement. Many Banks are flushed with cash (“excess reserves” as the USA CB calls them) that they don’t want to lend because there are no good lending opportunities.

As no new money enters the market, there is no inflation.

Voila! Yet another “Liquidity Trap”. Plenty of cash to be loaned but no sound takers. No inflation but no economic growth either.

 

EU Melts Down

The EU operates a little differently than any other single country. They have an EU CB and then country CBs. For any intent and purpose, country CBs have very little impact on each country economy.  This is so because they cannot create Euros out of thin air, only the EU CB can.

The general idea of the EU was that all its countries had more or less the same economic “strength” and therefore they could all function well without the need for individual CB’s to “manage” their economies differently.

This was and is a very idiotic idea. Even during the origins of EU, when politicians were dealing only with “economically strong” countries, it was clear that, for example, Italy (which survives on loans) is not the same as Germany (which loans out).  But, they went ahead and made it anyways.

For a few decades, as each country tried to come to terms with the fact that they could not inflate individually, they tried to manage their economies by borrowing. If you can’t print your own money, then borrow, borrow, borrow and then borrow same more. Same effect.

The debt in these “selected” EU countries skyrocketed. No worries, we have the solution. After the collapse of the USSR, EU politicians decided to invite to the EU a number economic powers such as Bulgaria, Latvia and Romania.

In a typical bureaucratic uber-stupid move, they tried the same solution that did not work before, not once or twice but five times! Yes, the EU was expanded 5 times so far and counting.

Consequence?  Peace, prosperity and unending love and brotherhood.

Are you kidding me!? Of course not!

What happened next was the equivalent of each country CB printing like crazy. You see, EU membership has its privileges. Just because a country becomes an EU member, all its previous economic sins are forgotten. In other words, countries that up to that moment had junk ratings, now became trusted and worthy of lending.

With this new status, came ludicrously lower Interest Rates and many, many new loans, all based on a mirage.  PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) being the main examples.

They borrowed left, right and center and the EU CB provided. With that money the lowered their internal Interest Rates and create an orgy of credit, with the exact same effects as it happened before in Japan and USA. Eventually, as these countries could not repay back not even the interests of their loan, a crisis began to develop when new loans are only offered at higher Interest Rates.

Exactly as it had happened before in Japan and USA, the EU countries (read Germany) were forced to step in and bail those countries out.  This worked for a few months. Eventually, even these bailouts were pathetically insufficient. Then, the EU CB suffered a coup and its Director was replaced by somebody else who was more “pliable” to political views. Read, willing to print, print, print and then print some more.

And so the EU CB did. And so the EU CB bailed out economically dead countries. And so the EU is not filled with, not zombie banks, but zombie countries!

This is progress!

And so, all this newly minted digital credit flows to dead countries who promptly return it as “payments” on loans.  Banks in all EU countries are in the same position, because they made gigantic loans to dead countries that they cannot recuperate. Voila! EU zombie banks in EU zombie countries.

And so, we again have ourselves a liquidity trap. There is plenty of credit to go around, but no inflation and no takers.

 

As Simple as 1, 2, 3

Do you begin to see the pattern? Allow us to spell it out for you:

1. CB “stimulates” the economy by printing tons of funny money
2. This funny money fuels ridiculous enterprises and speculative bubbles
3. CB becomes aware of the problem and then they “do something” by raising Interest Rates and therefore crashing the economy.

To “solve” this problem, CBs then print more money to support dead Banks and countries who cannot loan out this money, even if there would be takers.

Voila! High credit, no inflation and dead economies.

 

The Truth

Many pundits and so-called analysts out-there will attempt to give you all kinds of explanations. Be careful. The original reason for these meltdowns in simple: CBs printing money. Yes, it is that simple. The error of this process is not lack of regulation or de-regulation, CB mismanagement or political stupidity. The root cause of the problem is the existence of CBs and their funny money. Remove this factor and the entire problem goes away overnight.  The message is clear:

Central Banks are not only unnecessary, they are extremely harmful to any economy.

 

Beyond The Meltdown

We are not done yet with this story. There actually is an after-story. As usual, Argentina is our guiding zombie.

Argentina goes through these complete cycles every 5 to 7 years. Inflation, crash, stagnation… but it does not stop here. Something is different.

Indeed. In the same manner we explained what happens when people get used to the idea of inflation and raise Interest Rates on the expectation of inflation, since Argentinians went through so many of these cycles already, they developed an expectation of the end of the cycle which changes its outcome.

Think of it this way.  Argentinian CB inflates. Cheap credit is used. A bubble ensues. Interest Rates begin to climb until they reach unsustainable levels. The CB raises Interest Rates. The  economy crashes. The CB steps in to bail out Banks. There is plenty of credit but, this time Banks do lend and there are borrowers. Why? What’s different?

Simple. Banks and borrowers understand that the cycle will repeat itself again within a few years. They learned to anticipate. Banks need to make as much profit as possible while the going is good. Borrowers want to acquire as much physical goods as possible before the crash.  Remember that during the crash although goods are cheap, most people do not have money, and so they are not a bargain. The bargain is to purchase goods at the beginning of the cycle, borrowing on long term, low Interest Rates and let the inevitable inflation eat the loan away. Banks tolerate this because they either use floating Interest Rates or shorter lending terms and so, they can stay ahead of the Interest Rate raising curve.

Both have learned to live with the cycle.

This is the future that awaits us. People in USA, EU, Japan and everywhere else will go through this. It is inevitable. The existence of CB’s makes this inevitable.

 

Beyond The Meltdown Cycle

Is there a beyond, beyond? What happens next? We don’t know but we can speculate. Argentina has not reached that stage yet, but it came close in several occasions.

We know that when the cycles become shorter, the entire economy operates on a continued economic state of crisis. Crisis is now endemic and permanent.

If this state of affairs remains for a long time, people rise. It has happened before and it will happen again. When this happens, governments are powerless. Its police and armed forces are powerless. Yes, they can subdue some people for some time, but how do you subdue all people all the time in the middle of a crumbling economy? You can’t. The USSR tried it and it did not work.

So, what happens next, once people rise? They slowly begin to shift towards a government-less society. We have explained this in our lesson When Countries Dissolve. This is already half true in Argentina. Most of Argentinian laws are simply disregarded. The economy is becoming more and more cash oriented. The government, any and all governments are being bypassed and ignored. This trend will only accelerate as more and more people become aware of the problem and its only solution.

This “public education” is certainly something new.  It only started about 10 years ago with the advent of the Internet. Up to this point, the mainstream media controlled all the news and political indoctrination, but no more.

There is a purely common sense approach by Argentinian people at recognizing that the Democracy does not work at all and that the solution is to ignore it. However, this common sense approach is being constantly reinforced by new information coming through the Internet. Eventually, a critical mass will form, and then all attempts from any Democratic government to actually govern in any other capacity as pure formality, will be pointless. We look forward to that day when Argentina will lead us again, but this time out of the mess.

Note: please see the Glossary if you are unfamiliar with certain words.

Continue to Senseless Inflation and Interest Rates - Part 5