Road to Hyperinflation is paved with Market Accommodating Monetary Policy


Henry C.K. Liu

Part I:   A Crisis the Fed Helped to Create but Helpless to Cure
Part II: Central Banking History of Failing to Stabilize Markets

Part III: Inflation Targeting

Milton Friedman, the 1976 Nobel laureate in economics, identified through an exhaustive analysis of historical data the potential role of monetary policy as a key factor in shaping the course of inflation and business cycles, with the counterfactual conclusion that the Great Depression of the 1930s could have been avoided with appropriate Fed monetary easing to counteract destructive market forces. Friedman’s counterfactual conjecture, though not provable, has been accepted by central bankers as a magic monetary formula to rid capitalism of the curse of business cycles. It underpins the Greenspan-led Fed’s “when in doubt, ease” approach of the past 2 decades which had led to serial debt bubbles, each one biggest the previous one.

Macroeconomists, including current Fed Chairman Ben Bernanke,
focus their attention on the structure, systemic performance and behavioral interactions of the component parts of the economy. While they defend the merits of market fundamentalism, most neoclassical macroeconomists subscribe to the debt-deflation view of the Great Depression in which the collateral used to secure loans or as in the current situation, the backing behind their derivative instruments will eventually decrease in value, creating losses to borrowers, lenders and investors, leading to the need to restructure the loan terms or even loan recalls.  When that happens, macroeconomists believe that government intervention is necessary to keep the market from failing.

The term debt-deflation was coined by Irving Fisher in 1933, and refers to the way debt and deflation destabilizes each other. De-stability arises because the relation runs both ways: deflation causes financial distress, and financial distress in turn exacerbates deflation. This debt-deflation cycle is highly toxic in a debt-infested economy.

Hyman Minsky in The Financial-Instability Hypothesis: Capitalist processes and the behavior of the economy (1982) elaborated the debt-deflation concept to incorporate its effect on the asset market. He recognized that distress selling reduces asset prices, causing losses to agents with maturing debts. This reinforces more distress selling and reduces consumption and investment spending which deepen deflation.

Bernanke wrote in 1983 that debt-deflation generates wide-spread bankruptcy, impairing the process of credit intermediation. The resultant credit contraction depresses aggregate demand. Yet in a later paper: Should Central Banks Respond to Movements in Asset Prices? (2002) coauthored with Mark Gertler, Bernanke concludes that inflation-targeting central banks need not respond to asset prices, except insofar as they affect the inflation forecast. The paper refers to a 1982 paper by Oliver Blanchard and Mark Watson: Bubbles, Rational Expectations, and Financial Markets with the general conclusion that bubbles, in many markets, are consistent with rationality, that phenomena such as runaway asset prices and market crashes are consistent with rational bubbles.

Friedman’s conjecture on the effect of monetary policy on economic cycles drew on the ideas of neoclassical welfare economist Arthus Cecil Pigou (1877-1959) who asserts that governments can, via a mixture of taxes and subsidies, correct market failures such as debt-deflation by “internalizing the externalities” without direct intervention in markets. Pigou also proposes “sin taxes” on cigarettes and alcohol and environmental pollution. However, Pigou’s Theory of Unemployment (1933) was challenged conceptually three years after publication by his personal friend John Maynard Keynes in the latter’s highly influential classic: General Theory of Employment, Interest and Money (1936). Keynes advocated direct government interventionist policies through countercyclical fiscal and monetary measures of demand management, i.e. full employment.

are also influenced by the work of Irving Fisher (1867-1947): Nature of Capital and Income (1906) and elaborated on in The Rate of Interest (1907 and 1930), and his theory of the price level according to the Quantity Theory of Money as express by an equation of exchange: MV=PT ; where M=stock of money, P=price level, T=amount of transactions carried out using money, and V= the velocity of circulation of money. Fisher’s most significant theoretical contribution is the insight that total investment equals total savings (I=S), a truism that all debt bubbles violate.

The 1990s appeared to be a replay of many aspects of the 1920s when consumers and businesses relied on cheap and easy credit in a deregulated market to fuel an extended debt-driven boom which became toxic when an inevitable debt crisis caused asset price deflation. Federal Reserve banking regulations to prevent panics were ineffective and widespread debt defaults led to the contraction of the money supply. In the face of bad loans and worsening future prospects, banks abruptly became belatedly conservative in their lending while they scrambled to seek additional capital reserves which intensified deflationary pressures. The vicious cycle caused an accelerating downward spiral, turning an abrupt recession into a severe depression.

Bernanke points out in his Essays on the Great Depression (Princeton University Press, 2000) that Friedman argues in his influential Monetary History of the United States that the Great Depression was caused by monetary contraction which was the consequence of the Fed’s failure to address the escalating crises in the banking system by adding needed liquidity.  One of the reasons for the Fed’s inaction was that it had reached the legal limit on the amount of credit it could issue in the form of a gold-backed specie dollar by the gold in its possession. Today, the Fed has no such limitation on a fiat dollar, a condition that permits Bernanke to suggest the metaphor of dropping money from helicopters on the market to fight deflation caused by a liquidity crunch. Free from a gold-backed dollar, the Fed is now armed with a printing machine the ink for which is hyperinflation to fight deflation.

Yet in the popular press, Friedman was known also for his advocacy of deregulated free market as the best options for sustaining economic growth, which raises the question of the need for central banking intervention to replace specie money of constant value with fiat currency of flexible elasticity. A free money market under a central banking regime is an oxymoron. Betting on Fed interest moves is the biggest speculative force in the market. Friedman apparently did not extend his love for free trade to the money market. The Friedman compromise was to manage the structural contradiction with a proposed a steady expansion of the money supply at around 2%.

Still, Friedman’s love of free markets does not change that fact that totally free markets always lead to market failure. Free markets need regulation to remain free. Free market capitalism, the faith-based mantra of Larry Kudlow notwithstanding, is not the best path to prosperity; it is the shortest path to market failure.

Unregulated markets in goods have a structural tendency towards monopolistic market power to reduce price competition to inch towards rising inflation. On the other side of the coin, unregulated money markets can lead to liquidity crises that cause deflation. The fundamental contradiction about central banking is that the central bank is both a market regulator and a market participant. It sets the rules of the money market game while it pretends to help market to remain free by distorting the very same rules through the use of its monopolistic market power as a market participant not driven by profit motive. The Fed is a believer of free markets who at the same time does not trust free markets. The response by ingenious market participants to the Fed’s schizophrenia is to set up a parallel game in the arena of structured finance in which the Fed is increasingly reduced to the role of a mere passive spectator.

Rational Expectations

Robert Lucas, the 1995 Nobel laureate economist, also made fundamental contributions to the study of money, inflation, and business cycles, through the application of modern mathematics. Lucas formed what came to be known as the “rational expectations” theory. In essence, the theory asserts that expectations about the future can influence economic decisions by individuals, households and companies. Using complex mathematical models, Lucas showed statistically that individual market participants would anticipate and thus could easily counteract and undermine the impact of government economic policies and regulations. Rational expectations theory was embraced by the Reagan White House during its first term, but the doctrine worked against the Reagan “voodoo economics” instead of with it.

Inflation Targeting

In a debt bubble, an escalating rate of inflation to devalue the accumulated debt is needed to sustain the bubble. Thus conventional wisdom moves toward the view that the overriding purpose of monetary policy is to keep market expectations of price inflation anchored at a relatively benign rate to ward off hyperinflation. This approach is known in policy circles as inflation targeting on which Fed Chairman Ben Bernanke is an acknowledged academic authority and for which he had been a forceful advocate before coming to the Fed.

In May 2003, Pimco, the nation’s largest bond fund headed by Bill Gross, having earlier pronounced a critical view on the unrealistically low yield of General Electric bonds in the face of expected inflation, came out in support of inflation targeting. Fed economist Thomas Laubach, a recognized inflation targeting advocate, estimates in a paper that every additional $100 million increase in projected Federal annual fiscal budget deficit adds one quarter percentage point to the yield on 10-year Treasury bonds, albeit that this estimate has been rendered inoperative since the 1990s by dollar hegemony through which the US trade deficit is used to finance the US capital account surplus, reducing the impact of US fiscal deficits on long-term dollar interest rates. Global wage arbitrage also kept US inflation uncharacteristically low, albeit at a price of hollowing out the US manufacturing core.

Laubach was part of the Princeton gang that included John Taylor of the celebrated Taylor Rule, and Ben Bernanke, the money printer of late at the Fed. (Inflation Targeting: Lessons from the International Experience by Ben S. Bernanke, Thomas Laubach, Frederic S. Mishkin and Adam S. Posen; Princeton University Press 2001). The Fed’s long-held position is that Federal budget deficits raise long-term interest rates, over which Fed monetary policy as currently constituted has little control.

The Taylor Rule

Economist John Taylor was the editor for Monetary Policy Rules (National Bureau of Economic Research Studies in Income and Wealth – University of Chicago Press 1999) in which he put forth the Taylor Rule.

The Taylor Rule states: if inflation is one percentage point above the Fed’s goal, short-term interest rate should rise by 1.5 percentage points to contain it. And if an economy’s total output is one percentage point below its full capacity, rates should fall by half a percentage point to compensate for it.  The rule was designed to provide “recommendations” for how a central bank should set short-term interest rates as economic conditions change to achieve both its short-run goal for stabilizing the economy and its long-run goal for fighting inflation.

Specifically, the rule states that the “real” short-term interest rate (that is, the interest rate adjusted for inflation) should be determined according to three factors: (1) where actual inflation is relative to the targeted level that the Fed wishes to achieve, (2) how far economic activity is above or below its “full employment” level, and (3) what the level of the short-term interest rate is that would be consistent with full employment.

The rule “recommends” a relatively high interest rate (a “tight” monetary policy) when inflation is above its target (normally below 2%) or when the economy is above its full employment level (normally defined as 4% unemployment, but this figure has risen in recent years to 6%), and a relatively low interest rate (a “loose” monetary policy) in the opposite situations. Under stagflation when inflation may be above the Fed target when the economy is below full employment, the rule provides guidance to policy makers on how to balance these competing considerations in setting an appropriate level for the interest rate. The answer is a neutral interest rate. Yet as a practical matter, the only way to counter stagflation is to lean on the anti-inflation bias as Paul Volcker did during the Carter years because a neutral interest rate may extend stagflation longer than necessary.

Although the Fed does not explicitly follow the rule, analyses show that the rule does a fairly accurate job of describing how monetary policy actually has been conducted during the past decade under Chairman Greenspan. This is in fact one of the criticisms of the Taylor Rule in that it tends to reflect Fed action rather than to guide it. On the question whether the Fed should have leaned against accelerating home prices during 2003-2005, Taylor rule simulations suggest that the Fed should perhaps have been thinking of itself as one important cause of that phenomenon in the first place.

The Mystery of Neutral Interest Rates

Journalist Greg Ip of the Wall Street Journal reported on December 5, 2005 that in a written response to a letter from Rep. Jim Saxton (R- NJ), chairman of Joint Economic Committee of Congress, about the meaning of a neutral interest rate as invoked by Fed Chairman Greenspan’s testimony, Greenspan says that definitions of neutral vary, as do methods of calculating them and that neutral levels change with economic conditions.

Thus the concept of a neutral rate is made useless by practical difficulties.  This of course was a standard Greenspan position of all economic concepts as the wizard of bubbleland always drove by the seat of his pants, doing the opposite of his obscure official pronouncements. With the Fed widely expected to raise the FFR target to 4.25% the following week in a continuation of the traditional policy of “measured pace”, up from its low of 1% in June 2004, and with the 10-year yield at 4.5%, the yield curve was approaching flat, and an inversion soon if the Fed, as expected, continued its interest rate raising policy.  Historically, a flat yield curve signals future slow growth and an inverse yield curve signals future recession.

But Greenpsan, invoking rational expectations theory, dismissed the historical pattern by arguing that lenders were likely to accept low long-term rates because of their expectation of future low inflation, and this would stimulate future economic activities.  So stop worrying about the inverse yield curve. It was an attitude that continued when an inverse yield curve emerged again in the early 2000s.

There is no denying that the US economy, as well as the global economy, had been plagued with persistent overcapacity. And if low inflation, as defined by the Fed, is the result of slow wage increases, where in the world can the future expansion of demand come from? Many analysts, particularly in the bond markets, have sharply criticized the Fed for keeping interest rates too low for too long and ignoring signs of incipient and insipid inflation.

In his Monday, December 5, 2005 Congressional testimony, Mr. Greenspan reiterated his view that recent price increases were mainly a result of “transitory factors,” such as rising oil prices. True to his Keynesian past, Greenspan also pointed out that corporate profit had been so high that businesses had ample room to offer higher wages without raising prices to consumers. But of course, supply-side economics requires corporate profits to boost return on capital rather than boost demand by raising wages. And management never voluntarily raises wages without being pressured to by labor strikes, let alone for the good of the economy. To management, the only thing good for the economy is corporate profit. 

The surprisingly tentative tone of Greenspan’s residual Keynesian outlook contrasted with the more extended attempt in his testimony on the following Tuesday to buttress his view that core inflation, which excludes volatile areas like food and energy prices, is likely to remain below 2% through the end of next year.  But despite his optimism about inflation remaining under wraps, Greenspan cautioned investors against thinking that the Fed might feel less constrained in unwinding its cheap-money policies of the last three years from 2001 to 2004.

In the June 30, 2004 Congressional hearing, Greenspan carefully dodged an opening question from Senator Richard C. Shelby, Republican of Alabama and the chairman of the Senate Banking Committee, on whether the Fed would raise the federal funds rate another quarter-point at its August 2004 meeting. Greenspan also refused to be pinned down on what was in many ways the most basic question: What constitutes a ''neutral'' interest rate that Greenspan claims he tries to follow that neither provokes inflation nor slows down the economy?

Many economists have suggested that a “neutral'” fed funds rate -- the rate charged on overnight loans between banks and the key policy tool the Fed relies on to guide the economy -- is between 4 to 5%. That would have been a big increase from the June 30, 2004 fed funds rate level of 1.25%.

Like the famous description of pornography from Supreme Court Justice Potter Stewart, Greenspan said people would know the rate when it arrived. “You can tell whether you're below or above, but until you're there, you're not quite sure you are there,” he said. “And we know at this stage, at one and a quarter percent federal funds rate; that we are below neutral. When we arrive at neutral, we will know it.”

Economists have highlighted numerous difficulties in estimating the neutral federal funds rate in real time, including data and model uncertainty, which can result in estimates that are off by a couple of percentage points. These difficulties add to the challenge of conducting monetary policy, especially when the fed funds target is near the neutral rate, because policymakers must make their decisions without the benefit of reliable data. Therefore, policymakers will be especially attentive at this stage to incoming data. And, until research finds a solution to the difficulties of estimating the neutral rate, the conduct of policy will remain both a science and an art.

Market Expectations Undermine Inflation Targeting

The problem is that according to “rational expectations” theory, market expectation can undermine the Fed’s inflation targeting policy to push tolerance for inflation increasingly higher until it reaches hyperinflation. Inflation targeting advocates therefore argue that inflation targeting should encompass a dual objective of holding down inflation as well as preventing deflation.

The financial press, grasping at straws in the wind to anticipate Fed policy, highlighted Fed Chairman Bernanke’s January 10, 2008 speech at the Women in Housing and Finance and Exchequer Club Joint Luncheon in Washington, D.C. on Financial Markets, the Economic Outlook, and Monetary Policy as signal of the Fed standing “ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.”

Bernanke also said:any tendency of inflation expectations to become unmoored or for the Fed’s inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and reduce the central bank’s policy flexibility to counter shortfalls in growth in the future. Accordingly, in the months ahead we will be closely monitoring the inflation situation, particularly as regards to inflation expectations.”

Thus the Fed is restrained in its interest rate action not only by actual incoming inflation data, but also by data on inflation expectations. This means that when the market expects the Fed to cut interest rates, it actually limits the ability of the Fed to cut rates.

After the Fed’s January 2008 unprecedented and drastic interest rate cuts, the market has been anticipating that the European Central Bank (ECB) would need to follow the Fed’s lead to lower euro rates significantly.  Yet while the ECB faces similar dilemma as the Fed with regard to simultaneous vigorous inflation and slowing growth, the ECB is limited by its singular mandate of restraining inflation, unlike the Fed’s dual mandate of price stability and support for growth and employment.  Jean-Claude Trichet, head of the ECB, testified in front of the European Parliament that inflation remains the ECB’s prime focus to “solidly anchor inflation expectations.”

The euro zone economies are saddled with a less flexible structure of wage volatility that cannot adjust quickly to price changes as in the
US because most European wage contracts are indexed to inflation but not to deflation. Unlike their US counterparts, European companies cannot layoff workers as easily, or adopt a two-tier wage and benefit regime for new workers. <> 

Market expectation is focused on the inevitability of a euro-zone slowdown form the financial market turmoil that had originated from the
US in August 2007 and on the prospect of euro interest rate reduction in the face of asset price correction despite a strong euro against the dollar. Yet European politics will not allow political leaders to be complacent about a strong euro buoyant by a flight from a deteriorating dollar while euro economies face a decline from global depression caused by a slowdown in the US economy.  In the current global trade regime, the depreciation of the dollar will bring down the value of all other currencies. Exchange rate fluctuations only reflect temporary differentials in the rate of decline in the purchasing power of different currencies. Even as the euro falls against the dollar, it continues to lose real purchasing power.

Democrat-Controlled Congress Wants Employment Targeting

As early as February 19, 2007, half a year before the August emergence of the credit crisis, Representative Barney Frank of the 4th Congressional District of Massachusetts, the Democratic chairman of the House Financial Services Committee, told The Financial Times it would be a “terrible mistake” for the Fed to adopt inflation targeting to guide its interest rate decisions.  Frank, whose committee is the House counterpart of the Senate committee charged with oversight of the US central bank, said such targeting “would come at the expense of equal consideration of the [the Fed’s] other main goal, that is employment.”

By that Frank meant inflation targeting could be used to keep inflation down at the expense of full employment. His comments came as Fed policymakers entered the final stages of a far-reaching strategy review that included detailed debate over the merits of adopting an inflation target. What Frank opposed was the prospect that the Fed would fight inflation by keeping interest rate above that needed to produce low unemployment.

Fed Chairman Bernanke believes that the central bank would be better off with a relatively flexible inflation target – one that would be achieved on average, rather than within a specific time frame, giving maximum latitude to respond to exogenous output shocks. Critics point out that this could lead to the Fed alternatively overshooting and undershooting in the short term, creating undesirable volatility in the market. This is because incoming economic data are known to be unreliable and need subsequent revision.

Further, in order to make any such policy change, Bernanke would need at least the tacit consent of key figures in Congress. Frank’s unequivocal statements against inflation targeting as it impacts even short-term unemployment suggest this consent will still be difficult to secure even after generally favorable congressional hearings. Frank told The Financial Times that Bernanke “has a statutory mandate for stable prices and low unemployment. If you target one of them, and not the other, it seems to me that will inevitably be favored.” The reality could be that neither stable prices nor low unemployment can be achieved by short-term flexible inflation targeting.

Advocates of an inflation target at the Fed say it is important to distinguish between the relatively rigid form of targeting as used by the Bank of England, and the relatively flexible form favored by Bernanke. Frank, however, said he would not support even a flexible target “without equal attention to unemployment also.”  What Frank wants is a low unemployment target to link to a low inflation target. The fear is stagflation with high unemployment accompanied by high inflation.

Inflation Expectation around the World

Inflation expectation has been rising everywhere in the world, driven in part by rational expectation on the part of market participants. Beyond price data on oil and food, US core inflation in the 2.2 - 2.3% range since April 2006 has been above the central bank’s stated comfort level of 1.6% to 1.9% for some time. Further, the “core rate” is designed to sooth the financial markets and to distract market participants from the reality of rising inflation. The core rate does not exist anywhere in the real economy. It is a fictional notion designed to disguise inflation to justify perpetual real negative interest rates. And negative real interest rates have an upward spiral effect on inflation trends.

And in the euro-zone, even a rising euro has not stopped inflation from rising to 3% in November 2007, largely due to rising price of dollar-denominated imports, such as oil, outpacing the rise in exchange value of the euro. Evidence of second-round inflationary effects are already visible, with Europeans workers, most vocal in France and Germany, demanding wage increases to compensate for a loss of purchasing power beyond the acceptable range of accepted inflation and productivity targets. Member of the British police held a mass protest over pay in central London on January 23, 2008, angered by a 2.5% pay rise being backdated to only December 1, 2007 for member officers in England, Wales and Northern Ireland.

Long-term inflation expectations in the euro-zone, as expressed by interest rate futures, are running at nearly 2.5%, a robust 25 basis points above official ECB target of “close to but below 2%”. Forecasters expect euro-zone inflation to slow in 2008 but nobody is predicting that it will fall below target, let alone turn negative for the rest of the year, particularly if the dollar continues to decline in purchasing power. Responding to a declining dollar, oil and other key commodities prices denominated in dollars can be expected to rise in adjustment, causing inflationary pressure worldwide.

Global inflation outlook for 2008 does not justify an accommodating monetary policy stance for any central bank. Risk of a recession in the US looms larger by the day from the collapse of the debt bubble, yet monetary policy is not an effective tool to prevent that prospect. A debt bubble will eventually have to burst to allow overblown asset prices to self-correct. If a central bank, as Greenspan claims, should not and cannot intervene on asset prices on the way up, but starts to target them on the way down, it fuels inflationary expectations. Low interest rates had caused the price bubble; and resorting to lowering interest rates to keep prices up after the bubble burst risks hyperinflation.

If higher inflation to the level needed to sustain the expanding debt bubble is tolerated, serious convulsions in global bond markets and the foreign exchange market and serious disruption to the global flows of funds can be expected. If high inflation is not tolerated, a violent burst of the debt bubble may be the outcome. While the market pushes the Fed to allow inflation to moderate price correction, it is far from clear that the damage to the global economy from inflation will be less than that from market price correction.

Inflation Expectations in Emerging markets

Measuring inflation expectations in emerging markets requires different methods since competition for export market share has neutralized wage-price spirals common for the developed economies. This is so despite the fact that food and energy account for a much larger share of total spending in poorer countries than in rich ones, making it harder for workers to absorb price increases without demanding higher wages to compensate. The core rate of inflation, excluding food and energy, is moderate in most parts of the world and strikingly low in some of the fastest-growing economies in the world, including Saudi Arabia and even China, where core inflation was just 1.1% in October, 2007. Headline inflation in China was 6.5% in August, 2007 with food prices leading the rise.

Food prices increase was exacerbated by an outbreak of porcine reproductive and respiratory syndrome (“blue-ear” disease) that has affected pig supplies, pushing the year-on-year increase in meat and poultry product prices to 49% in August. 2007. Pork alone accounts for around 4% of the basket used for the consumer price index, so movements in its price have a direct feed-through into inflation. The cost of eggs rose by 23.6% year on year in August, moderating from a peak of 34.8% in June. Vegetable prices were up 22.5% over a year ago. Aquatic-product prices are also gaining momentum. Food accounted for 37% of the average total spending of a Chinese urban household in 2005.

The Fed and Global Stagflation

While inflation expectations remain locked at moderate rates, food and energy prices will continue rising above-average rates because of anticipated decline in the purchasing power of the dollar, causing overall inflation to escalate globally as the global economy slows. The Fed is betting on its aggressive rate cutting moves to turn 1970s-style “stagflation” into mere inflation.

Until the end of 2007, many financial executives, market participants, influential commentators and government policymakers had insisted publicly that last summer’s credit squeeze would prove short-lived and containable. Suddenly, in the course of a few weeks, bankers and regulators have been forced to face reality and to admit that the shock that began in August was merely the first sign of widespread financial collapse that would take years to unwind.

Sharp Fall Off of Market Confidence

Market confidence fell abruptly off a cliff, with banks wary of lending to each other while investors stop buying new securitized debt instruments. Borrowing costs in the money markets rose dramatically to put pressure on corporate borrowers, private equity acquisition and commercial real estate finance.

Fear has spread to the entire global market, partly due to lack of transparency behind the credit crisis that began in the US. Projected losses continue to rise with no end in sight. The problem is made worse by the self-inflicted loss of credibility on the part of top government officials and leading financial executives.

For example, Fed Chairman Bernanke first suggested that the subprime mortgage crisis would result in a manageable $50 billion in losses. Less than three months later, he tripled the projected loss to $150 billion but still denying any threat of systemic contagion. Speaking after the February 9 meeting of Group of Seven finance ministers, Peer Steinbrück of Germany said the G7 now feared that write-offs of losses on securities linked to US subprime mortgages could reach $400 billion, sharply higher than the $150 billion credit losses that the Fed, Wall Street banks and other institutions have revealed in recent weeks. The latest panic-stricken Fed interest rate cuts are telling market participants to expect losses that could amount to trillions.

AIG, The world’s biggest insurance company by assets, sent tremors through the markets on February 12 when the insurance company raised its estimate of losses in October and November from insuring mortgage-related instruments from about $1 billion to $5 billion.  AIG shares tumbled 11%, wiping $14 billion off its market value. AIG has written $78 billion of credit default swaps on CDOs, which protect the purchaser from a CDO’s failure to pay. The primary providers of the hedges are bond insurers such as MBIA and Ambac, whose ability to pay claims is causing deep anxiety in global markets. These have written about $125 billion of protection on “senior tranches” of CDOs. Catherine Seifert, analyst at Standard & Poor’s, was quoted in the Financial Times that AIG would “have an extremely difficult time regaining investor confidence”.

How many times can public figures be shown wrong by subsequent unfolding events before losing total credibility? The overused truism is now flooding the media: that credibility is like virginity – much easier to lose than to get it back. Like the resourceful pimp who promotes the virgin-like freshness of his prostitute by claiming that it is only her second sexual encounter, the “good fundamentals” of the economy is touted over and over again by influential public figures in the face of deepening systemic collapse and dwindling confidence. Gratuitous advice that the market was temporarily oversold and that every decline session presents a “buying opportunity” continues to be standard pronouncement by those who are in the position to know better.

The faith-based Larry Kudlow & Company program on CNBC, where participants are asked to declare with solemn piety: “I believe free market capitalism is the best route to prosperity” as an article of faith, is increasing attracting viewers for its entertainment value rather than for the quality of its analysis, particularly when the host continues to repeat with a straight face his tiresome mantra that goldilocks economy is alive and well in the face of serious systemic financial disaster.

Losses Exceeding $1 Trillion

Back in the real world, Goldman Sachs analysts estimate that the total final loss on US subprime mortgages would exceed 80% of its March 2007 face value of $1.3 trillion, even if the meltdown does not spread throughout the $20 trillion total residential mortgage outstanding and beyond the housing sector into commercial real estate and corporate finance.

The bulk of this loss will ultimately be borne by pension funds whence the average worker around the world expects to receive money to fund his/her retirement needs. Market forces can resolve the financial crisis with a sharp and quick price correction from bubble levels but the politically sensitive Fed and Treasury are trying to engineering a “soft landing” by extending the debt bubble, the penalty for which would be a decade or more of stagflation. Pathetically, supply-side market fundamentalists are clamoring for more government bail out of the market, with “damn the economy” frenzy. It is the equivalent of the God-fearing faithful asking the Devil for help in easing the ordeal of faith.

Dollar Hegemony and Loose Monetary Policy

The benefits of a loose monetary policy are by now proving to be dramatically short of what their advocates have claimed. A protracted policy bias towards low interest rates led the economy into its current debt quagmire, particularly when the unearned profit of the debt-driven boom has gone to a select manipulating few, leaving the masses with debts unsustainable by income. More low interest rates will perhaps help the wayward financial institutions delay inevitable insolvency but will not get the economy out of its debt crisis without pain. The argument that subprime mortgages helped expand homeownership is false. Such mortgages only put buyers into homes they cannot otherwise afford by distorting the happy American dream into an unneeded financial nightmare.

Easy money has been one of the most tempting monetary fallacies for all governments all through civilization. It has brought down the mightiest of empires, from Rome to dynastic China. But the one basic requirement for sustaining the value of money is that it must not be easy to come by without equivalent input of value. In the current international architecture based on fiat money, governments of trading nations justifies inflationary monetary policy with the need to lower currency exchange rates to compete for market share in international trade. Inflation is driven by global trade.

The Bernanke Fed seems to have followed Greenspan’s pattern of adopting traditional gradualism only when interest rates are on the way up to retrain inflation, but always abandoning gradualism on the way down to stimulate growth, thus introducing a long-term structural bias in favor of inflation. The Fed then frequently finds itself behind the curve in fighting inflation expectation and overshooting to combat deflation expectation. This unbalanced proclivity has contributed to the long-term decline of the purchasing power of the dollar on top of the fiscal and current account twin deficits. Yet the US has been the privileged beneficiary of this easy fiat money fallacy through dollar hegemony since 1971 when President Nixon abandoned the Bretton Woods fixed exchange rate regime based on a gold-backed dollar. And this fallacy of the benefits of easy fiat money is about to be exposed by hard data for even the printer of the fiat dollar.

The Age of Worker Capitalism

There was a time in the past under industrial capitalism when in a class war between capitalists and workers, moderate inflation could help workers keep their jobs by keeping the economy expanding and make it easier for them to pay off their debts to capitalists. But nowadays, under finance capitalism when capital comes mostly not from capitalists, but from enforced savings held by worker pension funds, inflation robs workers of their retirement resources while stagflation lays them off from their current jobs.

Capital has been manipulated as a notional value on which derivative transactions are calculated and profit and loss are realized. Finance capitalism, through income disparity condoned by supply-side ideology of keeping profit for the rich in the name of capital formation and letting the working poor be taken care of through trickling down from the rich, has constructed a financial infrastructure that channel profits to a few and assigns losses to the many.  The inequity is mind-boggling. At least the capitalists of industrial capitalism used their own money. In finance capitalism, the retirement funds of workers are manipulated by financiers to exploit workers.

A Flawed International Finance Architecture

In April 2002, the term dollar hegemony was put forth by me in Asia Times on Line in a critical analysis of a post-Cold-War geopolitical phenomenon in which the US dollar, a fiat currency, continues to assume the status of primary reserve currency in the international finance architecture that finances global trade. Architecture is an art the aesthetics of which is based on moral goodness, of which the current international finance architecture is visibly deficient.

Thus dollar hegemony is objectionable not only because the dollar, as a fiat currency, usurps a role it does not deserve, thus distorting the effects of trade, but also because its impact on the world community is devoid of moral goodness, because it destroys the ability of sovereign governments beside the US to use sovereign credit to finance the development their domestic economies, and forces them to export to earn dollar reserves to maintain the exchange value of their own currencies. Exporting economies are forced to accumulate dollars that cannot be spent domestically without severe monetary penalty and must reinvest these dollars back into the dollar economy.

The Bretton Woods II Theory Fallacy

In 2003, economists Michael Dooley, David Folkerts-Landau and Peter Garber proposed what has since become known as the Bretton Woods II theory. The theory turns dollar hegemony from the destructive monetary scam that it is into an assenting fantasy by applauding it as a happy win-win arrangement in which newly industrialized countries peg their currencies to the fiat dollar at an undervalued exchange rate in pursuit of export-led growth; and in return, they reinvest their trade surplus dollars back into the US, which acts as an economic anchor and consumer of last resort. This warped theory fed the illusion that the US trade deficit can be reversed by merely forcing trade surplus partners to upward revalue their currencies. The 1985 Plaza Accord succeeded in pushing the Japanese yen up against the dollar and threw Japan into a two-decade-long recession without reversing the US trade deficit.

By 2006, the US was running a current account deficit in excess of 6% of its gross domestic product, a level that would normally be considered excessive and unsustainable while the capital starved exporting economies in Asia were holding large amounts of US debt. The Bretton Woods II theory says that this state of affairs is both desirable and sustainable, a dubious claim clearly disproved by facts by now. There may still be some who argue that dollar hegemony is desirable but no one can deny it is clearly unsustainable. If this currency abuse is practiced by any other government, the International Monetary Fund (IMF), a creation of the Bretton Woods regime, would impose austere “conditionalities” on its fiscal budget to restore the exchange value of the currency. With dollar hegemony, the US, the nation with the longest continuous current account deficit in history and the world largest debtor, is exempt from such IMF imposed austerity discipline on its fiscal budget.

Dollar Hegemony Engenders US Protectionism

The net result of the injurious effects of dollar hegemony is the emergence of anti-trade protectionism even within the US, the supposedly lead beneficiary of the Bretton Woods II regime, particularly the segment of the US population that has unevenly borne the pain of free trade. For the exporting economies, there are growing signs that political leaders are beginning to realize that export-led growth is not the panacea that neoliberal market fundamentalism has made it out to be. Exporting for dollars that cannot be invested at home has left all exporting economies starved for capital for domestic development, with serious disparity of income and wealth, and political instability resulting from unbalance development. While much of domestic politics in the exporting countries is distorted by uneven power held by special interests of the export sector, a collapse in global trade will shift the balance of political power back towards the domestic sector.

The circular fund flow from US current account deficit back into US capital account surplus appeared to have come to a sudden halt in the summer of 2007. The US Treasury International Capital System (TICS) data show a massive drop in net foreign purchases of US long-term securities since the end of June, dropping from $99.9 billion to $19.5 billion in July and to a negative $70.6 billion in August, bouncing back to a positive $26.4 billion in September.  All the while, US current account deficit has been running about $80 billion a month.

Dollar Hegemony Feeds the Debt Bubble

What dollar hegemony does over time is to feed the US debt bubble and steadily weaken the value of the dollar while it hollows out the US industrial core, as US policymakers in both the Clinton and Bush administrations tirelessly assert that a strong dollar is the national interest. Whenever the dollar debt bubble burst in the last two decades, as it again did in August 2007, and the Fed had been forced into the fad of a monetary easing mode, i.e. lowering dollar interest rates not just temporarily but kept it low for long periods. The effect has been to force the purchasing power of the dollar to fall which then induced other central banks to let their currencies fall as well to protect their competive export market shares and to preserve the value of their dollar holdings in local currency terms. A competitive currency devaluation war will eventually unravel dollar hegemony in a disorderly fashion into a spiral of global hyperinflation. That eventuality appears to be at hand in 2008.

The collapse of dollar hegemony can accelerate the emergence of an Asian regional currency regime, along the lines of what happened in Europe after the collapse of the Bretton Woods regime in 1971. There has been a lot of talk for a long time about Asian monetary union, with little progress so far. See my July 12, 2002 article on The case for an Asian Monetary Fund in Asia Times on Line.

Prisoners Dilemma for Foreign Central Banks with Massive Dollar Holdings

The dollar’s fall in exchange value relative to the euro is costly for all central banks holding large amounts of dollar-denominated financial assets whose economy also imports from euro-zone, even when dollar denominated commodities continue to appreciate in price. By holding and continuing to accumulate large amounts of dollars from trade surplus, these central banks have a powerful incentive to ensure that their dollar holdings retain their purchasing power and exchange value in relation to their own currencies. Yet if these foreign central banks perceive the US Fed as powerless to halt the fall of the dollar by its unwillingness to keep dollar interest rate appropriately high, because the Fed prefers a robust market to a strong economy, they would have an equally powerful incentive to sell off their dollars while there is still a market for them or to compete to buy hard assets that would cause prices to rise. Both of these moves will lead to dollar hyperinflation.

This situation creates a well-known “prisoners’ dilemma” for central banks with massive dollar holdings. Collectively, these central banks have a compelling incentive to hold on to their dollars to avoid a massive sell off that hurts everyone, so as to maintain the dollar’s value on world currency markets for the common good. Yet individually, each central bank has an incentive to sell dollars and diversify its holdings into other currencies or hard asset before the market collapses from other central banks selling ahead of the others to gain individual advantage. This fear of defection from a common interest leads to a classic prisoners’ dilemma, and the risk that these dollar-holding central banks will simultaneously try to diversify their currency portfolios poses the greatest threat toward a run on the dollar. The Western oil companies have been playing this game of the prisoners’ dilemma against OPEC members for decades to induce individual producers to cheat for advantage by selling more than its share of the allotted quota, causing Saudi Arabia, the lead producer, to keep oil prices up by cutting its own production below its allotted quota to minimize the effect of individual defection. The Saudi’s role as swing producers held the cartel together. The
US, unlike Saudi Arabia, has thus far shown no inclination of cutting down the production of fiat dollars.

The Triffin Dilemma of 1960

The Triffin dilemma, name after Belgian-American economist Robert Triffin who first identified it in 1960, is the problem of fundamental currency imbalances in the Bretton Woods regime. With dollars flowing overseas through the Marshall Plan, US military spending and US citizens buying foreign goods and US tourists spending aboard, the amount of euro-dollars in circulation soon exceeded the amount of gold backing them. By the early 1960s, an ounce of gold could be exchanged for $40 in London, even though the official price in the US remained $35 by law. This difference showed that the market knew the dollar was overvalued and that time for gold-backed dollar was running out.

The solution was to reduce the amount of dollars in circulation by cutting the US balance of payments deficit and raising dollar interest rates to attract dollars back into the country. But these moves would drag the US economy into recession, a prospect President John F. Kennedy found politically unacceptable. This was posed as the famous Triffin dilemma to Congress as an explanation why the Bretton Woods regime had to collapse inevitably. Triffin noted that there was a fundamental liquidity dilemma when one country’s national fiat currency was used as a global reserve currency for trade. The very structural advantage would cause that country to lose any resolve to maintain the value of its fiat currency.

As the post-war world economy grew, more dollars were needed to finance it. To supply global dollar liquidity, the US must run a deficit, as no other government could produce dollars. But to maintain credibility of its currency, the US must not run a deficit. That was the fundamental dilemma. In the end, the US opted to continue to run a balance of payments deficit, which led to the loss of credibility and the collapse of the Bretton Woods regime in 1971.

However, if the United States stopped running balance of payments deficits, the global economy would lose its largest source to monetary reserves. The resulting shortage of liquidity could pull the world economy into a contracting spiral, leading to economic, social and political instability.

How Long will Foreign Central Banks subsidize Dollar Hegemony

Some argue that it is not the business of central banks to maximize the return on their exchange reserve portfolio, but to protect and enhance the stability of domestic financial markets and, in the case of central banks of large economies, global financial stability. In other words, foreign central banks that hold of massive dollar reserves from trade surplus are expected to pay the price of exchange rate losses to sustain the current international global financial infrastructure based on the fiat dollar. Yet the profit made from the exchange rate losses sustained by the foreign central banks went disproportionately to the international financial elite, causing income disparity everywhere that held back consumption demand which became a critical structural problem when the global economy moved into an overcapacity mode.

Whether and for how much longer this counter salutary arrangement can be sustained depends on the degree and rate of decline of the dollar and the disproportionately low purchasing power of workers in the US and the rest of the world. Foreign central banks may become convinced that the US has neither the intention nor the resolve to keep the dollars strong beyond rhetoric, or the ideology to let domestic and foreign workers have a larger share of global corporate earnings. When that happens, the incentive for foreign central banks to hold onto the dollar in hope of an eventual reversal of its declining value may vanish very suddenly either as a result of financial logic or political pressure.

Credit Rating Fiasco

Shortly after the outbreak the credit crisis of August 2007, as the supposedly low-risk instruments became victims of unanticipated risk swelling from below, the monetary policy establishment began looking for a scapegoat and found it in the failure of the rating agencies to account properly for the complexity of the securitized instruments, relying overly on faulty mathematical models to override conventional prudent risk management.

It is true that rating agencies operate under a conflict of interest, their fees being paid by the issuers of the debt instrument they rate. Yet the underlying logic of the rating agencies’ permissive blessing rested on a reasoned assumption: that the explosive growth in credit derivatives and collateralized debt obligations (CDO) of recent years around the world had been enabled, if not caused, by US-led monetary policy under the leadership of Alan Greenspan at the Fed and Robert Rubin at the Treasury, and that this monetary policy of easy money would continue forever.  Dollar hegemony, though unavoidably presenting a long-term threat to the US-controlled international finance architecture, was as close to a free lunch in monetary economics as one could get.

The Destructiveness of Dollar Hegemony

Dollar hegemony allowed the US to soak up the world’s wealth with persistent negative real interest rates to finance US spending. After Clinton, the Bush tax cuts, with the help of Greenspan’s loose monetary policy, sustained the global debt bubble with reflation, the act of stimulating the economy artificially by increasing the money supply during stagnant growth and by regressive tax reduction during periods of rising fiscal deficits.

Global broad marketing of securitized debt instruments has shifted credit monitoring from direct lender knowledge of the credit history of individual borrowers to aggregate credit rating based on statistical probabilities constructed from theoretical borrower profiles and behavior patterns, much like the fundamental assumption of the rational economic man by neoclassical economics.  More and more mortgages were written on the assumption of home prices continuing to rise, thus reducing concern for borrower credit rating to near zero.  The safety of mortgage-back securities depended entirely on expected rising prices of homes and not on the credit worthiness of the borrower. In fact, a subprime borrower is more likely to refinance regularly to siphon rising home value into bank profits than a prime borrower.

As house price stopped rising and began to fall, irresponsible borrower behavior surprised the risk models.  Many borrowers stopped mortgage payments not because they were cash strapped, but because they did not want to feed a mortgage that would soon exceed the market value of their houses.  The abnormally rapid rise of distressed mortgages upset the statistical credit hierarchy of the mathematical models and caused a sudden credit squeeze. As the credit squeeze persists, ratings agencies were being forced to downgrade hundreds of thousands of debt securities, after failing to foresee the on-coming waves of defaults initialized by subprime borrowers.

For example, on the last Wednesday night in January 2008 alone, Standard & Poor’s reportedly downgraded more than 8,000 residential mortgage-related securities with a market value of $534 billion. These downgrades in turn triggered bitter recriminations, amid a wave of losses at asset management firms and banks. The Financial Times quotes Wes Edens, head of Fortress Investment Group, a leading fund with over $40 billion in assets under management: “Much of the money lost has been held by people who held AAA securities [that were downgraded]. That has caused a tremendous loss of confidence.”

At the root of the rating collapse was the reliance on risk management models that assume human behavior to remain unchanged in times of financial distress as during times of financial euphoria. Delinquency rates on home mortgages jumped much more abruptly than historical trends, with many subprime borrowers stopping payment on their home mortgages before halting payments on their credit cards or automotive loans – turning the traditional delinquency pattern on its head. As a result, mortgage lenders face losses at a much earlier stage in a credit crisis than in the past and within much shorter time frames.

This is partly because many subprime mortgagees were first time homeowners who had little or no equity in their new homes and did not particularly consider keeping their new home as a top priority, rendering the assumed risk profiles inoperative when house prices fell. Unlike home buyer of previous times who bought a house to have a home, many in this new group of house buyers in the debt bubble tends to view their houses as vehicles of investment driven by financial calculation with little or no emotional attachment. Many bought and sold a house every year, each time moving into a bigger house the payments for which have no relationship to their income.

Bank data show that a large number of current mortgage defaults are not linked to temporary cash flow shortfalls but to borrowers having bought houses at prices their income could not carry. These borrowers depend on refinancing at rising home value to handle their mortgage payments. Mortgage delinquencies started to surge as soon as house prices started to fall, which prevented overstretched households with unaffordable loans from refinancing their way out of trouble. These buyers were a key factor in turbo-charging the rise in home prices during the debt-driven boom; they are a key factor in turbo-charging in the rise of defaults when the boom busts.

Borrowers with high loan-to-value mortgages or negative equity have no incentive to maintain payments when house prices started to fall below the value of the mortgage even if they were able to. No one likes to feed a dead horse.

Borrowers appear to favor their cars more than their houses in which they had no equity stake. IMF data show delinquency rates on prime loans made in 2006 and 2007, too late to benefit from house price gains before the debt bubble burst, rose more quickly than delinquencies on similar prime loans made in 2003 or 2004.

With a presidential election on the horizon, official attention has been focused on the problem of payment “resets” which allegedly pushed subprime borrowers with loans at initial, ultra-low “teaser” rates to default. The Bush administration brokered a plan to freeze resets while Treasury officials privately admitted that the scheme is not a “silver bullet” because recent mortgage data show a surprisingly weak correlation between rate resets and delinquencies. The main factor remains borrower attitude and behavior distorted by massive debt with reduced punitive consequence for the borrower from default.

Debt Bubble Destroys America’s Admirable National Character

The debt bubble fed by dollar hegemony had hollowed out more than just America’s industrial core; it has also hollowed out America’s moral core and filled it with unprincipled greed. The American idea of home ownership as a symbol of a free society in which any citizen can earn with honest hard work and financial discipline a home for his/her family has been punctured and replaced by a vile fantasy that a home can be bought with no equity, with unrealistic interest and amortization payment schedules based not on the buyer’s current and expected future income, but on rising home prices made possible by the deliberate easy money policy of the Federal Reserve, supposedly the nation’s keeper of the value of its currency.

Some market cheerleaders continued to argue for months after August 2007 that the US jobs market could stay healthy to keep the credit crisis from spreading to the general economy. But the job growth in recent decades has been concentrated in the financial service sector which cannot continue in a distressed financial system. By the end of 2007, even the most optimistic analysts had to acknowledge that December consumer spending decline signaled that the US is slipping into recession that can result in a protracted period of rising unemployment. “The problems in the credit markets are spreading to the consumer sector – the next area of concern is auto loans and credit cards,” says John Thain, newly appointed chief executive of Merrill Lynch who replaced the discharged chief after the giant brokerage disclosed massive losses from subprime mortgage related investments.

Since repeal of Glass Steagall in 1999, mega-banks have been able to re-enact the same kinds of structural conflicts of interests that were endemic in the 1920s -- lending to speculators, packaging and securitizing debts, marketing structured financial instruments backed by bank credit line and extracting lucrative fees at every step along the way in blatant conflicts of interests. And, much of these debt instruments are even more complex and opaque to bank examiners than their counterparts were in the go-go 1920s. Much of it is virtual obligation tied to the solvency of other instruments supercharged by complex computer model of assumed variables and relationships. Structured finance, instead of preserving liquidity and hedging unit risk, turns out to be the detonator of systemic risk and liquidity draught, exacerbated by explosively high leverage. The problem is multiplied by the lack of transparency.

The rise in prices destroyed the purchasing power of wages and government revenues, and the government responded to this by printing money to replace the lost revenues but left most wages relatively fixed. This was the beginning of a vicious circle. Each increase in the quantity of money in circulation brought about a further inflation of prices, reducing the purchasing power of incomes and government revenues, and leading to more printing of money. In the extreme, the monetary system simply collapses while the economy remains technically robust.

Hyperinflation is a State of Mind

This is the way that hyperinflation takes root: by a self-reinforcing vicious cycle of printing money, leading to inflation, leading to printing more money, and so on. Hyperinflation is not defined by merely a super high rate of inflation, but the general acceptance of the compounded inflationary effect of a vicious cycle of debt. This is one reason why incipient inflation is feared, that even a little inflation one year will lead to more next year, and so on, building exponentially by compound interest.

There is a general knee-jerk market psychology associating rising asset prices with economic health and falling asset prices with economy distress. Yet some economies have experienced steady price rises up to 50 to 100% per year without falling into a cycle of hyperinflation, if such rise is anchored by real economic growth.  And there has never been a hyperinflation cycle that could not have been avoided or broken by a simple government determination to stop the expansion of the money supply for speculation purposes.

Keynes Warns Against Inflation

John Maynard Keynes who advocated deficit financing to counter cyclical depression, warned about the danger of inflation: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

The key point is that a monetary system can only function if the value of the monetary unit is relatively stable so that any increase in the quantity of money reflects a corresponding increase in real wealth. Monetary elasticity should not be confused with tolerance for inflation. Hyperinflation is not just prices rising at an extremely high rate. It means that inflation is out of control and price levels are detached from the value of underlying assets. Most of all, hyperinflation can only exist if society loses faith in itself and accepts further resistance of it as a lost cause.

War and Hyperinflation

War is the mother of all inflation. Modem democratic governments always find it easy to borrow than to level taxes needed to pay for war. To pay back the mounting national debt, the temptation for inflation is irresistible. As the wave of inflation of the 60s and 70s which began around 1965, was triggered by the enormous cost of the Vietnam War, the current wave of inflation is tied to the two wars in Afghanistan and Iraq and the homeland security costs related to the global war on terrorism. As with the Vietnam War which failed either to contain the spread of communism in the Southeaster nation, or to strengthen the US economy, the current war on terrorism will only drag down the US economy without improving US national security.

Rubinomics Exports Inflation to Emerging Economies

At least the inflation of the Vietnam War was partly caused by the social dividend of Lyndon B. Johnson’s Great Society spending, albeit paid for with the inflation equivalent of a 20% capital tax on all savings held as cash, bonds, insurance and on pension payments and other fixed income. Today, under the dynamics of “Rubinomics”, the US through dollar hegemony exports inflation to all emerging economies that export to the US.

The Federal Reserve for the past two decades have not been able to check inflation, even as it succeeded in slowing down the US economy, but global prices have continued to rise, pushed by the demands of the emerging economies. The reason is that the world’s growing population is consuming food, energy and basic commodities faster our market economy can produce them, ironically because full production capacity cannot be tapped due to insufficient worker income to support unmet consumption. Inflation has developed momentum with excess money that has flowed to those who will not spend it, but to invest it.

The market has lost faith that governments will have the political courage to adopt needed policies to remodel the antiquate plumbing of systemic cash flow needed to keep the economy growing without debt or inflation. Current market forces react to fixated inflation expectations which in turn exacerbate inflation pressure in a self-fulfilling prophecy.  The world must stop looking to the flawed institution of central banking to bail it out of a monumental debt crisis with more debt. The current debt crisis presents an opportunity for a catharsis to reform the greed-infected global economy away from senseless and wasteful competition, toward cooperative enterprise to rebuild a new world community based on human values, to achieve equality without conformity, with compassion for the less fortunate and respect for diversity. The wind of change is sweeping the world.