The Fiat Money End Game – to Infinity and Beyond

The Fiat Money End Game – to Infinity and Beyond
Profile photo of Michael Rozeff

Jim Sinclair has a slogan “QE to infinity.” That’s “Quantitative Easing to infinity.” That’s inflation to infinity. That’s the case for gold and silver in a nutshell. I think he’s right. I’d like to explain why I think he’s right, but in a roundabout way that gives me a chance to express some of my thoughts on the financial crisis we are observing.

The last time we had a really serious depression, the public didn’t start massively flying into quality for quite some time. Currency held by the public was stable all the way to October 1930. At that point, there was an increase in Midwestern bank failures. And the Bank of United States failed. The New York banking department tried mightily to save it and merge it, but the Clearing House banks doomed the deal. They didn’t trust the bank’s real estate holdings. These events triggered bank runs, which meant currency withdrawals. That created deflation in money supply, with its depressing economic effects. This is because currency is part of the money base and enters the money multiplier and multiple deposit expansion. Starting in October of 1930, the curve of currency held by the public suddenly started to rise. That accelerated the drop in money supply that was already occurring. In the pre-Fed days, the banks would have suspended payments en masse and stopped the resulting chain of bank failures. Since the Fed was around, they were more complacent. The Fed, however, didn’t stop the chain reaction. The banking system fell apart, which means bank closures became endemic into 1933.

Compare September 2008. The authorities could not save Lehman or maybe did not. The Fed says they tried (see here), which makes the Lehman event very much like the Bank of United States event. This triggered a stock market panic and a flight to currency and safety much like October of 1930 and in other panics. We had an old-fashioned panic. People even shifted out of money market funds. Even with insured deposits, people still flew to safety all across the board. Picking and choosing who will fail and who won’t fail is a mish-mash policy. The captains of the fiat money-big debt-big government-fractional-reserve system, who want to keep their jobs and see the system survive, either have to save it in the usual ways, inflation and taxpayer-funded bailouts, or else end the system altogether, which, of course, ain’t goin’ to happen if they can help it. The logic of the system has only one direction: rescues, more inflation, more bailouts, and the invention of new kinds of credits and currencies. The call for worldwide currency baskets is a step toward the ultimate bubble-making machine, a world fiat currency.

This time around, unlike October of 1930, the Fed counteracted the panic with massive inflation, so now we have a new scenario that differs from 1931-1933. Bernanke studied his Friedman & Schwartz. He knew how to stop a chain of failures. But, funny thing, the broader money aggregates are still moribund and bank failures are still occurring. Stopping the bank runs doesn’t solve the insolvency problems of banks with illiquid assets whose values are so much lower than their liabilities (by 30-50% it appears.) Inflation is not a cure all.

The Emergency Banking Act of 1933 included a host of inflation measures. They included purchase of preferred stock of banks by the Reconstruction Finance Agency. This reminds one of the TARP program in 2008. Inflation is built into the fractional-reserve system as a rescue device, and so is the taxpayer-funded bailout. Everything to save a flawed system rather than fix it properly, for it cannot be fixed without getting rid of the accompanying big government.

If the EU lets Greece fail, it’s like letting Lehman fail in 2008 or the Bank of United States fail in 1930. It sends out a signal. The dithering of the EU may already have sent out such a signal. They may already have altered expectations and behavior. The rescue package may lack believability for the moment. It may not have sunk in quite yet.

The rescue team, which consists of the stronger countries and the IMF, are damned if they do and damned if they don’t. Instead of banks being insolvent with runs occurring on them as in the 1930s and 2008, we have whole countries being bankrupt, but their paper is held by banks in France and elsewhere, so there is a contagion thing to worry about. If the EU lets default happen, there is a run against all the bonds of all the weaker countries. Their yields rise, and they have to default too, and then that weakens a host of banks and others who hold the paper, and then they demand to be bailed out. If instead they rescue Greece and others, then the rescuing governments have to issue more debt, or else the IMF does too, or else the ECB gets into the act too, and this weakens the stronger countries and drives down the euro. So, either way, there are problems. It appears that the rescue option has been invoked, although tardily and reluctantly. This means that the governments are rescuing the bondholding banks and whoever else holds the Greek paper. That’s the bailout here. This is preferable to the rescuers as compared with an outright default which then starts a contagion via the bond yields rising sharply which induces country bankruptcies and defaults.

The deflation at work here has already happened. It’s that the values of loans held by banks have declined a great deal, and are below the values of their liabilities. The fractional-reserve banking system doesn’t work today and it didn’t work in the 1930s and at other times when depositors demanded cash or gold and the banks couldn’t liquidate assets or gain access to cash flows to pay them. Even with the Fed turning bank loans into cash, the FDIC has to keep closing banks every week because they are way below any regulatory standards of operation.

Central bank inflation is necessary in this kind of a fiat money-fractional-reserve banking system to prevent the whole system from collapsing due to flight to safety. More money is like a blood transfusion to a patient who is losing blood. But this doesn’t resolve the insolvency in the system. The regulators have what is called “forbearance.” They ignore the insolvency and do not enforce mark to market. They then close the worst banks and hope that the rest make enough money to rebuild their liquidity. Gradually, as the banks use reserves that cost them 0% to invest in U.S. Treasuries at 3.5%, they make some money. The Treasury market stays firm for this reason. The Fed keeps rates low for this reason. The banks build up potential liquidity by holding treasuries. In a few years, they sell these and start making more loans, and price inflation starts appearing. Meanwhile, the economy limps along. This is the muddle-through scenario.

The boom-bust cycle had to end with a deflationary bust. The central bankers eventually prick bubbles to stop inflation, because if inflation takes hold and interest rates rise, the government finances are doomed. And so, the latest boom-bust cycle did come to an end. Greenspan, toward the end of his reign, and Bernanke caused this bust by restricting money growth. Most people don’t know this. One has only to look at money growth to see this. Look at the very low rates of growth of money between 2005 and 2008. There was a deceleration.

M1 Money Stock

The Fed was fighting inflation from 2005 into 2008. However, a money and banking system and an economic system built on fiat money inflation cannot handle that. It’s geared to inflation. Deflation sends the economy into a tailspin. It shocks the banking system. In this case, the shock was severe. Bernanke didn’t expect that. He thought it was just another mild post-World War II style recession.

Bernanke was forced into inflating again. Apart from the Lehman event/misstep or maybe because of it, he did.

His only somewhat strange behavior was to bail out Fannie Mae with $1.25 trillion of MBS purchases. Why did he do that? My guess is he thought that would stimulate the housing sector and revive the economy. Probably that’s the reason. I say that because in the past, the Fed always created housing (and auto) revivals whenever it inflated out of recessions. That was like clockwork. So the Fed probably figured that since the Fed Funds rate was already 0%, they had to buy these mortgage securities directly in order to revive the economy.

Greece is merely one instance of the basic malady of the whole fiat money system: DEBT. From the moment that money can be created without the constraint of gold, from 1971 onwards, that’s when the DEBT curve lifts off and just goes parabolic. The fractional-reserve banking system just multiplies the DEBT incredibly. Here is an example, showing the federal government’s debt.

Federal Government Debt

Why do the borrowers borrow so much? The banks are like dope pushers, but why are there so many addicts? Why do people and governments go into debt so deeply?

Why do people borrow so much? They pretty much do what they’re told to do. They are taught to borrow and encouraged to borrow. It’s made easy. They get credit cards in the mail. They want to consume more now.

Inflation changes the prevailing attitudes. People become more consumerist at the margin. Keep up with the Joneses. Buy something that you imagine is crucial to your life and happiness, which, as it turns out, isn’t. In the housing case, there were all sorts of teaser rates and inducements, plus the speculative hope of making a profit. The banks were mailing out dozens of credit cards. These offers are still hitting selected mail boxes. So people fell for it. This continued a trend of installment buying that started in the 1920s.

The government’s behavior is understandable. Voters don’t really control legislators, and they get all sorts of political benefits by borrowing and spending. That’s their life. Ordinary folks hardly ever worry about government debt. It’s never paid off. Everyone thinks that it’s someone else’s debts. Who worries apart from some kooks? So getting rid of the gold constraint has unleashed a huge government debt bubble. Now, remember, when this debt gets too large, the governments either (a) default outright, or (b) the stronger ones rescue the weaker — for awhile. But here’s the catch. Eventually, they all have to default, every last government with excessive debt, which means that the yields will have to go up, as they have in Greece. That’s going to trigger a REVOLUTION.

Faced with handling mountainous debt levels, the governments either walk away from all bondholders everywhere, this is feasible, or else they inflate and pay them off in nominal terms, or some combination of these two paths. It’s these two options that we need to think through as to their effects, in order to decide which one they are likely to choose. So far, the big guys, the U.S. and Britain and Japan and probably China, have gone for inflating. They’re trying not to default outright. Why? The outright default basically ends the government’s ability to pay pensioners, poor people, and keep government spending up. So it revolutionizes the government itself. It ends government as we know it for awhile, and as far as politicians are concerned who have only one life to live, that’s too long. The only reason that the smaller countries who default (there are many, many such defaults) have survived their defaults and kept going is that the bigger countries refinance them, through their banks and through the IMF and World Bank. But there’s no one who can finance the U.S. if it defaults!!! So it won’t default, because of the revolutionary results of shrinking the government drastically. Therefore, of the two options, it will choose inflation. But how can it inflate without causing the government’s interest costs to soar, which will bring down the government and terminate the system? It can’t. And so we are back to default of some kind. The default or default-cum-inflation will have to be suppressed and/or controlled and/or moved to a higher level through a new lender of last resort. Someone will dream up some tricks that will wreck the wealth of the bag holders. It’s only a question of who they are going to be. Example: What the government can do is issue a new dollar that’s worth two of the old dollars, by fiat. If it owes $1,000, it pays off with $500 of the new dollars. But, again by fiat, it makes everyone else accept the new dollars on par with the old dollars. In this way, the government defaults on its loans to all its creditors, who get half what they expected. The government debt is thereby cut in half. Of course, lenders will now want twice the interest rate. So the government, by fiat, makes banks or savers or both, take its bonds at the old interest rate. It’s simple. Power can attempt anything in order to preserve itself.

Quantitative easing to infinity is the slogan of James Sinclair, and he is right. The fiat money-big debt-big government system cannot go on without QE to infinity. That’s what the system is all about. It has to run its course on this racetrack. It’s not about to jump the fence and run on some other course. But before it reaches the finish line, we are liable to see some changes in the way the race is run.

Profile photo of Michael Rozeff

Michael Rozeff is Professor Emeritus in the Finance and Managerial Economics Department, University of Buffalo. Dr. Rozeff has published articles on stock market pricing, earnings forecasting, corporate dividend policy, corporate divestiture, insider trading, and the Asian stock markets. He has been associate editor of several finance journals. Dr. Rozeff's recent articles on economics and politics are archived at

More in Articles


The Lesson Revisited

Henry HazlittSeptember 22, 2017

FDR and the Collectivist Wave

Ralph RaicoSeptember 21, 2017

Paul Gottfried on Fascism

David GordonSeptember 20, 2017

Marxist and Austrian Class Analysis

Hans-Hermann HoppeSeptember 19, 2017

When They Promise To Bring Back Manufacturing Jobs, They’re Promising Stagnation

John TamnySeptember 18, 2017

Wartime’s Lost Liberties

Doug CaseySeptember 15, 2017

Is Terror Good for the Economy?

Benjamin PowellSeptember 14, 2017

Lost Causes on the Left

Gary NorthSeptember 13, 2017

A War To Communize America

Frank ChodorovSeptember 12, 2017