Gregor Macdonald

If you have not yet read Part I, available free to all readers, please click here to read it first.

Part II: How the European Endgame Will Be the Death Knell For Modern Central Banking

Central Banks Becoming Increasingly Desperate

Has Europe decided to print its way out of the crisis? The big-bang announcement last week among global central banks suggests as much. Unfortunately, the global US dollar swap solution only patches up the liquidity portion of Europe’s present dilemma and does nothing to address the solvency issue.

As readers know, I take the mildly heretical view that “money-printing” in our present debt deflation actually functions as a status-quo maintainer. It does not risk hyperinflation, but instead keeps social confidence intact — at low levels, of course — as the familiar institutions of Western economies are maintained. Hard defaults, on the other hand, especially hard defaults that appear out of the hands of either fiscal or monetary policy makers, risk a confidence collapse on a large scale.

In my view, hyperinflation typically begins with a broad rejection of a country’s sovereign debt. This is the initial threshold that is crossed on the path to currency rejection, as foreign holders exit first. Domestic institutions are more restricted, slower to react, often bound by investment mandates, and thus left “holding the bag,” as it were, on a country’s bonds. Eventually, domestic confidence in the currency itself is lost, as the public, having watched its institutions fail, rejects the currency.

In my view, Europe is still at very high risk for such a catastrophic outcome. No global central bank, including the European Central Bank (ECB), can change the fact that the debt of Greece, Portugal, Spain, and Italy cannot be supported realistically through economic growth. But there is still time for the ECB to change its charter and buy that debt. The coordinated central-bank actions this past week will have virtually no consequence unless the ECB conducts QE (quantitative easing) on a massive scale.

Probabilistically, I have to favor the idea that Europe was given the lifeline on the condition that the fiscal union discussed in Europe and the permission granted to the ECB to conduct QE are both forthcoming. For the sake of social stability, I hope this happens. But I am not naive. Much of the debt that the ECB would purchase under such a regime, just like much of the junk debt now on the Fed’s balance sheet, will never recover its par (full price) value. Certainly not in real (inflation-adjusted) terms. But if the ECB does not “print money,” then we will move directly to hard defaults. And the hyperinflation risk that is currently masked by the common currency to the Eurozone will eventually be unveiled.