Center for Strategic Assessment and forecasts

Autonomous non-profit organization

Home / Economy and Finance / Causes and nature of the current crisis / Articles
What the outcome of the experiment with paper money
Material posted: Publication date: 25-12-2013

Based on a paper currency system contains the seeds of its own destruction. The temptation of the monopoly producer of money to increase the money supply almost insurmountable.

In such a system with the ever increasing amount of money in circulation and, as a consequence, constantly increasing prices, it makes little sense to preserve cash to continue to acquire assets. The best strategy based on this scenario will be to get into debt to buy assets and later pay off the debt with devalued currency. Moreover, it makes sense to buy assets that then can be given as collateral for further Bank loans. System with paper money leads to excessive debt.

This is especially true for new players such as large companies, banks and the government who have the right to expect that they would be receiving financial assistance from the newly created money.

We are now in a situation that for a system of paper money looks like a dead-end. After the last loop cycle, the government saved a bad investment in the private sector and increased social spending, which resulted in the rapid growth of budget deficits and debt. Central banks printed money to buy government debt (or taking it as security on loans the banking system) at an unprecedented rate. Interest rates were cut to almost zero. Budget deficits remain large. No significant real growth is not in sight. At the same time, the banking system and other financial players sit on mountains of public debt. In case of default of the state there would be instant bankruptcy of the banking sector. Raising interest rates to more realistic values or sell purchased the Central Bank's assets would put at risk the solvency of the banking sector, companies with high debt and government. The feeling that an avalanche of bankruptcies may provoke even slowing the printing of money (now referred to as "the curtailment of quantitative easing"). Does not seem high and the probability of radical cuts in government spending and deficits, given the existing in democratic countries, the incentives for politicians.

So, will the printing of money with close to zero interest rates constant as long until people lose faith in paper currency? Is it possible to sustain the system of paper money, or we will inevitably, sooner or later, we will get hyperinflation?

There are at least 7 possibilities:

1. Inflation. Governments and Central banks can simply continue to follow the path of inflation and print any necessary amount of money to support the banking system, governments and other over indebted entities. This will further increase moral hazard. This option ultimately leads to hyperinflation and thus to destruction of debt. Debtors win, investors lose. Paper wealth that people have saved for all their lives, will not be able to provide a high standard of living, as seemed before.

2. The refusal of social benefits. Governments can improve their financial situation, just not fulfilling their promises. So, the government can drastically cut back on state pensions, social insurance and unemployment benefits, to eliminate budget deficits and pay off the debts typed. Many benefits expected by the people, will be useless.

3. Default on debt. Governments can also refuse to pay the debts. This leads to the losses of banks and insurance companies have invested the savings of their clients in government bonds. People see the value of their mutual funds, investment funds and securities of insurance companies is falling, as a result, caused losses become apparent. The default of the government can lead to the collapse of the banking system. The avalanche of bankruptcies of over indebted entities would be economic Armageddon. Therefore, the policy until recently was doing everything to not let this scenario happen.

4. Of financial repression. Another way to get out of the debt trap is financial repression. Financial repression is the action to redirect more funds to the state and thereby facilitating the elimination of the national debt. Financial repression can be expressed in the legislation that reduces the attractiveness of investment alternatives, or, more directly, in regulating, encouraging investors to buy government bonds. Together with real growth and reduce costs, financial repression may play a role in the actual reduction of the debt burden of the government.

5. The repayment of debt. The problem of excessive debt may also be addressed through fiscal measures. The idea is to relieve government debt and to recapitalize banks through taxation. Reducing debt overload partially relieves the need for Central banks in keeping interest rates low and continue printing money. Currency can be put on a more reliable basis. To achieve this goal, the government EN masse is removing the wealth to pay off the national debt. The government simply increases the existing tax rates, or can resort to lump-sum withdrawals confiscatory wealth. Indeed, the IMF has recently proposed to introduce in Europe one-time 10% tax to reduce the high level of public debt. Large-scale cost reduction can also be used to pay off debts. After the Second world war, the USA was able to reduce its ratio of debt to GDP ratio from 130 percent in 1946 to 80 percent in 1952. However, it is unlikely that such a debt reduction through spending cuts will work again. This time the USA are not at the final stage of a successful war. A two-fold reduction in government spending with $ 118 billion in 1945 to 58 billion in 1947, has been achieved mainly through reductions in military spending. It seems unlikely that a similar reduction today without massive political resistance and bankruptcies over indebted entities that depend on government spending.

6. Monetary reform. There is the option of a full monetary reform, implying a (partial) default on government debt. He is very attractive, if you want to get rid of excessive debt without resorting to strong price inflation. It's like pressing the restart button and continue the regime of paper money. A similar reform was implemented in Germany after the Second world war (after the war financial repression was eliminated), when the old paper money of the Imperial coinage were replaced by new paper money, German marks. In this case, depositors who have huge amounts of old currency, are vulnerable to large-scale expropriation, but the burden of debt on many people will be reduced.

7. The involvement of investors. Can occur and the involvement of depositors, equivalent to half of the monetary reform. With the involvement of depositors as happened in Cyprus, the banks ' creditors (depositors) become shareholders of the banks. The debt of banks decreases and share price increases. Decreasing the money supply. The involvement of depositors recapitalized banking system and simultaneously eliminates bad debts. The shares may rise so that a partial default on government bonds would not threaten banking system stability. Depositors will suffer losses. For example, people that have invested in securities of companies in life insurance, which in turn bought the debts of banks, or government bonds will take losses. The excessive debt of banks and governments is reduced.

There may be any of the seven options, or combinations of two or more of them. In any case, they will make damages of explicit and put an end to the illusion of wealth. Basically, taxpayers, savers, or currency users are exploited to reduce debts and of currency translation on a more sustainable basis. Lump-sum tax on wealth, monetary reform, or the involvement of depositors are very unpopular policy options, make losses devastatingly obvious. The first option inflation is the governments much greater success, as it hides the costs of financial assistance over indebted entities. However, there is a danger that at some point, inflation gets out of control. And monopolist manufacturer the money does not want as a result of monetary collapse to destroy their privilege. Before you reach the stage of galloping inflation, governments will increasingly consider other options as these alternatives could lead to restart the system.


 

Source: MixedNews


RELATED MATERIALS: Economy and Finance
Возрастное ограничение