Weapons of Mass Inflation
By Adrian Ash
April 28, 2008
Dark secrets, looming disaster & the need
for urgent action haven't we been here before...?"
IN THE BOOMING economies of East Asia, governments fear mass
riots if food prices keep soaring.
Here in the rich West, politicians fear a 1930s-style depression if
consumers stop borrowing as home prices sink.
In sum, says the head of the International Monetary Fund (IMF), the
world is caught between "ice and fire". Which explains why central
bankers are hastily spooning out Baked Alaska.
The dilemma facing Western policy-makers looks stark enough.
Monetize the credit bubble by printing money to bail out the banks and
the cost of living will soar as the value of money evaporates. Or they can let
the bubble slip into default, dragging the banks into bankruptcy, and destroy
money itself in a new Great Deflation.
Hence the sloppy compromise cooked up by the big central banks.
Don't lend cash directly to cover the investment banks' losses. Lend Treasury
bonds instead...accepting toxic mortgage-backed bonds as collateral...and THEN
lend out cash against the T-bonds instead!
"By swapping [UK] gilts rather than cash for [Residential
Mortgage-Backed Securities], the Bank ensures that there is no direct effect on
the stock of base money," notes Willem Buiter, a professor at the London
School of Economics, in his blog for the Financial Times.
But "of course, the banks who now find themselves with
excess gilts will sell them, either to other private parties who have
pockets of excessive liquidity [meaning cash] or, more likely, to the Bank of
England."
Here at BullionVault,
we can't help but imagine Monty Python running this skit. First Michael Palin
opens one teller's window and swaps T-bonds for junk before dashing to
another to swap the new bonds for cash.
He could keep shouting "No cash for junk here, sir!" in
an angry voice too, with all the inevitable, hilarious consequences.
"Why do the cash for RBMS swap in two stages?" demands
Buiter, a former Bank of England policy-maker. "Why make things simple when
they can be difficult, transparent when they can be made obscure?"
There's a straightforward answer, of course; obscurity works to
confuse the public. The Bank of England's new Special Liquidity Scheme just
like the Fed's Term-Auction and Term Securities Lending facilities keeps the
whole sorry sage safely buried in the pink pages.
Just swapping cash for junk, on the other hand, would be simple
enough to make front-page news. But there in the headlines instead, shlock-horror
wins out. Which suits both government and the investment banks fine.
"There is a 'growing case' for government intervention in the
US housing market to arrest the deterioration of global financial markets and
slowing economic growth," according to the British press.
Says who? Says "the association that represents global
financial institutions," that's who!
"Given the magnitude of the systemic and macro¬economic risks
the US faces, there is a growing case for a finely calibrated public
intervention, perhaps addressing both the demand-side as well as the supply-side
of the problem," according to the Institute of International Finance.
Indeed, this is "the largest financial shock since the Great
Depression" claims the International Monetary Fund. Which in turn props the
door open for government rescues and government meddling, of course.
"The credit crisis has made the idea of cross-border supervision of the
banking industry more palatable," according to the daily note from SIFMA,
the US securities institute.
Says who? Says Charlie McCreevy, commissioner for internal markets
and services at the European Union.
"The present crisis has really sharpened minds of European
members about how we would handle a cross border financial crisis,"
McCreevy told reporters in Brussels. And no doubt Bear Stearns stood on one side
of many cross-border derivative deals. So many, in fact, the Fed went to the
"very limit" of its powers as former chairman Paul Volcker puts it
because the option of letting Bear fail was simply too scary to contemplate.
"I do not know whether the risks justified the decisions not
only to act as lender of last resort to [Bear Stearns] but to take credit risk
on the Feds books," wrote Martin Wolf in the Financial Times
recently.
"But the officials involved are serious people. They must have
had reasons for their decisions."
Hmmm, sounds familiar, no? Dark secrets known only by top-level
officials; the public good trumping public disclosure; urgent action needed to
avert global disaster.
Haven't we heard this line before? Right around...ummm...five years
ago, in fact?
"My colleagues," announced Colin Powell then US
secretary of state to the United Nations on 5 Feb. 2003, "every
statement I make today is backed up by sources, solid sources. These are not
assertions. What we're giving you are facts and conclusions based on solid
intelligence."
As it turns out, Powell's "solid facts" came from one
single source, an Iraqi defector known only as "Curveball", during
interviews with the BND, the German intelligence service. Uncorroborated and in
fact wholly false, his assertions found their way this week into a parliamentary
hearing in Berlin. The Bundestag's Supervisory Committee is asking
how-in-the-hell a man deemed "unreliable" by the British intelligence
service wound up as sole justification of the US-UK invasion.
"Elements of his behavior strike us as typical of
fabricators," said MI6 in its assessment. "In truth, he was a
sex-obsessed alcoholic," screams the London press now. But no matter.
"The Prime Minister [Tony Blair] has made the case for the
need to deal with Saddam for some years with consistency," as the left-wing
Observer newspaper claimed ahead of the March 2003 invasion.
"Accused of becoming America's poodle, Blair, in fact, sticks to a
potentially unpopular course because he believes this to be right, and that the
threat from Iraqi weapons is real."
Back here in April '08, we'd rather not say whether Blair, Bush and
Powell actually knew their "facts" to be false. Similarly, no one can
guess at the trouble if Bear Stearns collapsed.
But you might want to consider the mischief caused to your pocket
by bailing it out.
"Many parts of America, long considered the breadbasket of the
world, are now confronting a once unthinkable phenomenon," writes Josh
Gerstein in the New York Sun: "Food rationing."
Okay, this is The Sun. But Gerstein points to
per-customer-limits imposed by the Costco chain on rice in Mountain View,
California. It's put customer-caps on oil and flour sales in Queens, New York.
"Due to the limited availability of rice, we are limiting rice
purchases based on your prior purchasing history," read a sign when
Gerstein found the chain's "largely Asian immigrant clientele" in
Mountain View grumbling about the new limits.
Store manager Stephanie Gordon then told CBS News that in 21 years
with the company, she's never "seen it like this before." Indeed,
"we're actually starting to see shortages here in the US," confirmed
Scott Faber of the Grocery Manufacturers Association on last Monday's Early
Show.
Then on Wednesday, Wal-Mart said it's rationing rice sales at its
Sam's Club chain of wholesalers.
How ever did we get here? Shortages on US shelves make for great
headlines of course. They also make it easy to blame third-world food riots and
protests on a shortage of supply as well.
But "there is food on the counters and on the shelves in
stores," said Paul Risley, a spokesman for the UN's World Food Program last
week. The problem in Asia, instead, is that at these soaring prices, "there
is a certain population that cannot afford that food."
"Supply is not the main constraint, but the huge price
increases are," confirms Rajat Nag, head of Asian Development Bank.
"That has a very massive impact on the poor and we need to focus on the
huge price increases."
Back here in the West, "the Fed has lots of firepower
left" says Greg Ip in the Wall Street Journal almost like he
checked with Ben Bernanke himself! In the developing world, in contrast, a
"silent famine" now looms.
Two different problems with two separate causes? After the world's
greatest bubble in money with the greatest cash bail-out to follow
somehow it seems unlikely.