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QE Credit CardThis article is more of a speculative nature with a flavour of "back to the past". Many pundits and economic commentators have discovered a new reality; a breakthrough idea that they consider revolutionary. QE is debt cancellation! Sorry, you talking to us? Aha… Uhum…Hohum… so what else is new?

The process goes more or less like this.

  1. Government issues bonds
  2. Central Bank prints money out of thin air
  3. Central Banks uses this money to buy Government Bonds
  4. Government pays Central Bank interests on bonds
  5. Upon expiration Central Bank returns interests to Government and
  6. Government pays Central Bank the principal for the expired bond…
  7. Which the Central Bank then uses to buy new Government Bonds

The idea is that for as long as the Central Bank continues to hold Government Bonds and roll them over at expiration, the government can receive all the freshly minted money that the Central Bank produces, free of charge. This is so because as the Central Bank belongs to the government, it returns all its profits to the government…profits that came from the government to begin with. In addition since the Central Bank answers to the government, the government simply order the Central Bank to keep rolling Government Bonds into the future forever.


The magical money making machine at work.

Pundits point out that in US the Fed has "retired" about 15% worth of US debt, in UK about 25% of debt was "cancelled" by the Bank of England, in Japan the number is about 20% (Bank of Japan) and in EU nobody knows with QE just starting but by the end of the year the number should approach approximately 10% (European Central Bank). And this is good right? Meaning cancelling government debt is good news, right?

Not a chance.

This is not government debt cancellation; this is simply creating money out of thin air and spending it, however convoluted the method may be. This is simple to prove. If we follow the money and ignore all intermediate steps, we get:

  1. Central Banks prints money and gives it to the government
  2. The government spends printed money
  3. Done!

See what we mean? The issue is not debt cancellation or no debt cancellation, the problem is money being created out of thin air and then spent. Let's be clear. Let's assume for a second that Central Banks print sufficient money to so-called "cancel" 100% of a country's debt, and then what?

Do you actually believe that governments will suddenly stop spending? That by some sort of miracle politicians will see the light and maintain balanced budgets with no trickery nor borrowing under the table? Not a chance in hell! They have now discovered the magic money making machine that can go on forever! Their jobs are assured…or so they think.

The reality is that they have discovered absolutely nothing. This is something that many countries have been doing for a very long time, Argentina among them. As we mentioned before, we like Argentina because it is at the forefront of upcoming economic collapses and as such a model to study in detail. The Argentine Central Bank has been using this trick probably going back to 1826. So much for "cutting edge" thinking.

All of this is of historical significance, but what interests us is not what happened or what is happening, the big question is what will happen in the future?

For this we must revert to the past to the Bretton-Woods I and II agreements. These agreements forced countries to accept US dollars on an equal footing as gold when it came to count "assets" backing their own currencies. In the past every currency was related to the amount of physical gold stored in the respective Central Banks. However, after BW I and II gold was replaced by USD.

As a consequence of this trick, the US was allowed to export inflation throughout the world. It did not really matter how much the US would print, other countries will simply accept USD and kept them in their Central Banks hence preventing USDs from returning into US and creating inflation. This was a very good deal for US. Print all the money you want from thin air, spend it at face value and never worry about inflation! No wonder the 60's was such a prosperous time! It was fueled by funny money!

But why is this important? Because we are in the exact same situation today. The three most critical QE pundits (US, EU and Japan) also happen to have currency that it is widely recognized as "reserve", to the point that many Central Banks save it. As such and to a large degree US, EU and Japan can engage in massive QE without too much of a fear of igniting inflation locally.

Would this indicate then that everything is going to be OK?

Not a chance.

The problem is this. As QEs release more and more increasingly worthless currency, the markets will be unable to mop it up, partially because a side effect of QEs is to make exports to US, EU and Japan incredibly expensive. No exports means no currency. No currency means no storing of said currency in Central Banks. There is a limit as to how much can be pushed out and trapped. In this sense QEs are self-defeating.

Then we have banks which are not exactly lending; they are hoarding currencies out of fear of a 2008 version 2.0 event. However, these banks cannot do this forever. Eventually they all buy assets abroad thus creating international bubbles. In so doing they export these currencies which do get trapped in various Central Banks. However, this attitude has a limit in the sense that they are willing to spend only so much. Additionally, many of the "financial instruments" that they buy actually belong to those countries, this is, US, EU and Japan, which defeats the purpose because US, EU and Japan do not use each other's currency as assets in their respective Central Banks to any meaningful degree.

There are other mechanisms at work, but the summary is simple; there is only so much money that can be absorbed by the world. At some point governments, companies and people will realize that there is no difference between holding the depreciating EUR, JPY or USD or holding their own depreciating currency. At that point they will stop hoarding EUR, JPY and USD. And that will be the end of the happy printing age of QE.

How do we know this? Because it has happened in Argentina in the past. Between 1825 and 1881 Argentina issued the "Peso Moneda Corriente" which was issued as 1: 1 with the "Peso Fuerte" which was convertible to gold. In the beginning several countries held the "Peso Moneda Corriente" as a "reserve" but as the currency devaluated, it was dumped.

Of course, we are still far, far away from the dumping of EUR, JPY and USDs but we are on the way. We know that we are still a long way to go because as we calculated in our Default Index, countries do not begin to default until they hit the "magic" 1580% debt to Real GDP ratio. But even this is only valid for non-currency-reserve countries. For these countries (again, EU, US and Japan) we have no idea what the upper limit may be. However, we are sure of one thing; it exists.

And so governments and Central Bankers can keep playing their silly QE games all they want but in the end they are only hasting their own demise.

And so we arrive at the future. What happens after the expected QE failure? Same as happens in Argentina on a cyclical basis; inflation, hyperinflation, economic catastrophe, default, reset, begin a new cycle of hell (see Argentine Default - What A Depression Looks Like).

Countries such as the US, EU and Japan are economically arrogant and it could not be otherwise since they have been getting away with it for so long that it has become routine. But it won't last. This is the long term view.

However, there is a shorter view. This view has to do with the instability that QE programs create the world over. Due to the interconnectivity of world markets, a bubble popping in Brazil can easily trigger an economic catastrophe in Russia. And as we have seen, QEs do create bubbles the world over. Furthermore, a great deal of QE has been swallowed by derivatives (see The 1.5 Quadrillion USD Bet - What Can Possibly Go Wrong), which makes the possibility of a "cross cascading default" an almost certainty.

The point of this article is that it does not really matter how QE is used or interpreted or who does it, what matters is its size. The world is hooked on ZIRP (i.e. free) money and the second this stream end it spells the end of market continuity.

The only real question is who will be stupid enough to throw the last interest rate hike before the total collapse. For the looks of it, it would seem the US will have the privilege to sink the entire world in a new financial Dark Age. Will they do it? Will they really do it? Will the Fed play with matches on a world doused with gasoline? You can bet your underwear it will do it. Why? Because they are stupid, stupid, stupid Monetarists that look at the entire world through the eyes of so-called "Americans" (btw and FYI Yanks, America is a continent, not the United States of America, which is a country). It is very probable that at some point in the near future the Fed will rise one point to many and the whole thing will come crashing down.

How do we know this? Because they did it in 1929. Do you actually believe they learned anything since then? Not a chance in hell. Politicians are still very much in charge.

And so we will have yet another calamity to ascribe to the USA. This is indeed shaping to be the age of the USA, only not in a good way. Oh well… we can't wait to see who is the next power in line to which we will have to thank for upcoming calamities.

The future of humanity is tied to QE, this much is certain. We also know that humanity will absorb the blow and keep going. Eventually. But we have to ask. Was all this really necessary? Of course not. And there you have it. The truth.

And so we come to the conclusion of this article. The moral? What QE does or does not do is irrelevant. The problem, as usual, is that Central Banks print. But we can go a step beyond. We can ask why is it so and the answer is, again, simple; because politicians want it so. And so we come full circle. The problem at hand originates in governments, it is being treated by governments in a manner in which they will solve one problem and develop a larger number of bigger problems which will in turn be treated by governments… you get the picture. Is there any way out of this vicious cycle? Absolutely! Get rid of all governments. You can't you say? Fair enough. Start by not voting. Ever. Your choice, your future.

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

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