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Can Central Banks Create New Money Faster than the Markets Can Destroy Value?

By: Steve Johnson

6/29/2010 - 52 Comments

This is a very important question and the answer will determine which investment strategy is correct to navigate the deepening recession.

For the last two years, central banks all around the world have been pouring new money into their economies to try and slow the global recession.

But when the Greek bond market started to crash a few months ago, that changed everything.  Since then, austerity measures have been springing up all over the globe.

Culminating at the G-20 meeting last week, central banks are united in their idea that the time to flood the market with money has past and now is the time to cut spending to avert a debt crisis that could be much worse than facing the global recession.

They are in agreement that the cure (creating new money) is worse than the disease (global recession).

But what they are actually admitting is that the cure is the disease and the disease in the cure

Creating new money is the disease that has been growing for decades and the cure is the recession that they have been avoiding for decades.

And there is no plan B.

There is no other way to cure the disease other then stop feeding it.   Governments and central banks around the world are deeply committed to Keynesian economics—which is the crazy idea that prosperity can be produced by an increase in spending.

Keynesian economics has never led a single nation to prosperity, only bankruptcy and hyperinflation.

The Greece crisis has opened the eyes of central bankers who have suddenly realized they are on the path to complete economic collapse and that no-one is going to bail them out. 

EU and Asia Market Crash

With that in mind, the markets, which have been propped up by stimulus money, are going to be forced to adjust to the reality of the recession.   Without new money pouring in, the free market (which is you and me) will continue the process of destroying the value of phony asset prices. 

And after the markets sink, central banks will still have the trillions of debts that they created over the last few years. 

US Market Crash

Even if the US central banks continue to print money against the better judgement of rest of the central banks of the world, the equity markets will not be able to act independently, because they are highly coupled together and will all sink together.  

And because the Asia and European central banks are not going to match the money being created by the US central bank (the Federal Reserve), the US central bank will be forced to also stop creating money or risk a major drop in the value of the dollar.

Deflation

The result should be deflation or dropping prices in consumer goods (cars, houses), energy (oil) and commodities (gold, silver), equity markets and bonds. 

But during the crash, where are investors going to move their money to in order to avoid the drop in assets—perhaps gold or bonds? Then after the crash, where is the liquid money going to move too?  Gold is the most likely place.

What about the trillions that the US central bank has added to the economy over the last two years?  Dispite what they claim, I don't think it is possible for them to extract that money and therefore it will continue to push prices up—which is the results of inflation.

So we are going to see prices going up and down, depending on shifting consumer demands.

Hyper-inflation

If central banks begin moving their savings into other assets like gold and oil rather than US bonds, the rate of inflation in the US will be multiplied.

This could force the US central bank to quickly reverse course and instead of creating money, retract money from the economy—even as the unemployment rate is climbing, to avoid hyperinflation.

In summary, the global economic picture is about to take a drastic different direction because the central bankers are no longer in support of creating or borrowing more money. 

The answer to the question, "Can central banks create new money faster than the markets can destroy value?" is NO.

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