Whip Deflation Now

This morning, the ECB announced that it was joining the “QE” money-printers by expanding its asset purchasing programs to more kinds of junk in attempt to increase credit growth. Probably not coincidentally, Bill Gross’ monthly investment outlook for September explains what’s going on:

A credit-based financial economy (as opposed to pure cash) depends on an ever-expanding outstanding level of credit for its survival. Without additional credit, interest on previously issued liabilities cannot be paid absent the sale of existing assets, which in turn would lead to a vicious cycle of debt deflation, recession and ultimately depression.

Now this needs a little translation. For “credit-based financial economy” read “Ponzi scheme,” and for “ever-expanding outstanding level of credit” read “new money.” A Ponzi scheme is an investment fund that claims to pay higher returns to its investors than it is able to generate from investing the funds contributed, resulting in losses of investors’ capital that are concealed from the investors as long as possible. A “credit-based financial economy” and a Ponzi scheme are completely isomorphic, where the sponsor of the Ponzi scheme is the government instead of Bernie Madoff, and the investors are the citizens instead of the members of some country club in Palm Beach. When a Ponzi scheme starts to fail, new money flowing in is insufficient to pay the investors the returns that they expect or redeem their shares. In other words, money in the Ponzi becomes scarce. A “credit-based financial economy” fails in exactly the same way, that is new credit is insufficient and spendable money becomes scarce. Deflation, in other words.

The Ponzi scheme fails because the money put in has not been invested at a return sufficient to pay investors out of income (or invested at all in Bernie’s case). In the case of the economy, the credit money has been spent on consumption rather than investment. As Bill Gross summarizes: “Economic growth depends on the productive use of credit growth, something that is not occurring.”

The EU has clearly slipped over the edge of the cliff of insufficient credit growth. QE is a vain attempt to delay the inevitable. The US is teetering on the edge and will follow the EU down. Every Ponzi scheme is unsustainable and eventually fails, the bigger it is the more damage is done in the collapse. Credit-based financial economies are the same – unless of course they generate economic growth rates higher than the growth rate of credit.

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