Posted on 2020-02-27 20:57:00
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If our thesis is correct, that being bound together the purchasing power of the dollar and values of financial assets will probably collapse at the same time, we will see a different outcome from that which might otherwise be expected. Today, anyone discussing the consequences of monetary inflation would suggest the currency’s purchasing power will decline over a period of several years at an accelerating rate, giving those who recognise what’s happening time to protect themselves. This was the experience in Germany and some other European nations in the wake of the first World War. Instead, if it happens as described herein, the collapse will be extremely rapid, with bonds, equities and unbacked state currencies collapsing together in the space of less than a year. All that’s required is for the private sector to stop buying government bonds.
It has happened once before, exactly three hundred years ago. Like the central banks of today dealing with their governments’ debt, John Law in Paris had used the inflation of his own banknotes to ramp up the price of the Mississippi Company shares. By December 1719 Law’s scheme had begun to hit headwinds: the flood of his printed money into Mississippi shares fuelled profit taking. Law’s unbacked livres entered general circulation and led to a rise in price inflation.
The factor that finally undermined his scheme was the young King selling out the royal holding of 100,000 shares at 9,000 livres on 28 February for staged payments. It was a combination of a signal and too much supply for the market to bear, and both the shares and Law’s paper livres began to collapse. By the following September, while Mississippi shares still had a notional value of a few thousand livres, the livres were worthless.
The collapse of the currency preceded that of the shares by just a few months. Today, a similar tiredness around currencies prevails, whose purchasing power governments wittingly or unwittingly conceal. In recent years, price inflation in the United States has been running at about 10% in most major cities, based on evidence from independent analysts, not the goal-sought 2% of official figures.[ii] Given the standardisation of CPI method, we can assume price inflation in other jurisdictions is similarly understated. But we have yet to see the purchasing powers of unbacked fiat currencies begin to accelerate in their decline, as appeared to be the case in late-1719.
No matter. Instead, we should assess likely changes in monetary policy in the coming months. This time, we have the additional damage done to human interaction by the coronavirus. China’s economy, where production is ceasing and food prices are rocketing, could be evolving into a John Law-like collapse, in which case the currency will be next. Commentators are saying that once the virus passes, everything will return to normal. It won’t because the lies and hype that go with paper money will almost certainly have been exposed, as John Law found to his cost.
We can see that, rather like King Louis cashing out of John Law’s scheme in February 1720, in China the bullish spell is being challenged by the coronavirus. And China matters, being the world’s largest producer of consumer and intermediate production goods in the world. The Chinese government are expanding the money quantity rapidly to support the stock market and will also do so through state-owned banks in a vain attempt to support the wider economy. Just like John Law in those final three months.
The signal that it’s all going wrong for the yuan is likely to be reflected in demand for bitcoin, which can be bought online through peer-to-peer marketplaces, even by punters under quarantine (Chinese bitcoin exchanges were shut down by the government in 2017). At the time of writing, they were trading at a small premium to the dollar price. If that premium increases, or the number of bids suddenly jumps, it will be an indication that Chinese residents are beginning to lose faith in their currency. If the authorities try to ban peer-to-peer bitcoin sites, it will send a similar signal.[[iii]Even without the coronavirus spreading to other nations and undermining their economies directly, those who believe in the efficacy of their central bank’s monetary policy will begin to have doubts as not even negative interest rates have succeeded in stopping an economic decline. The error came from unswerving beliefs in the inflationary policies of John Law and John Maynard Keynes.