Expert Commentary

Gathering Storm Clouds of Deflation

This article was originally published in the July 2011 issue of The Elliott Wave Theorist.

This issue will list some of the ways that humans are beginning to wage war on credit, even as the mechanists are doing everything they can to defend it. The trends and events discussed below are widely known, but almost no one seems to connect them to the deflationary impulse. A major reason is because investors throughout the stock and commodity markets have been pie-eyed with optimism, so they have placed an inflationary spin on news events. But in order to have a chance of anticipating change, you have to look at developing forces, not the results of old ones. The developing forces, in my view, are deflationary.

An Emerging Public-Sector Frugality
Social mood is propelling the emergence of a new conservatism with respect to government spending. State austerity is on the wax in Greece, France and Britain. In the U.S., the Tea Party mentality -- the most consistent element of which is a desire to curtail government profligacy -- had some influence on the 2010 midterm elections. To get its candidates elected last year, the Republican Party had to release a Pledge to America, one element of which is to "cancel all future TARP payments." As a result, the 2010 midterm elections "effectively blocked [President Obama] from adding any stimulus spending." (AJC 11/8) The Republicans have also promised to balance the budget, which means curtailing spending and/or borrowing. Party promises are not worth the paper they are printed on, to be sure. But the slowly emerging sentiment that elected Republicans is real. Rand Paul is in the Senate. Municipalities are cutting spending in response to unbalanced budgets. Congressmen are at a standoff this month about raising the government's debt ceiling. A liberal U.S. President has just suggested a cut in Social Security spending. In January, Congressman Ron Paul, who has been waging a one-man war to abolish the Fed, became chairman of the House Subcommittee on Domestic Monetary Policy. The brakeman on the government-driven inflation train hasn't done much yet, but he is putting on his gloves.

The Fed Is Getting More Conservative
Although few seem to have noticed, the Fed's policy has actually became more conservative in terms of the quality of debt it is willing to hold. During QE0 in 2008, it bought just about anything, as long as it benefitted its financial buddies. But during QE1 and QE2, it added only Treasury securities, the traditional Fed investment, while working to divest itself of its non-federally-guaranteed paper. And what do you make of this development:

"Bank of America Corp. was close to finalizing a deal late Tuesday that calls for the lender to pay $8.5 billion to settle claims from a group of investors who bought mortgage-backed securities from the lender.... The investors...include the Federal Reserve Bank of New York." (AP, 6/29)

According to the perpetual inflation theme, the Fed is supposed to be printing money at will to cover the world's bad loans. Then why would the FRBNY care whether it is reimbursed for a batch of bad MBS investments? Isn't sucking money out of one of America's biggest banks a deflationary policy? The bank can't lend whatever it has to pay in fines. If the Fed really cares about the viability of its own assets, maybe runaway money-printing isn't so assured.

The Fed Is Encountering External Resistance
Many people believe that the Fed can inflate at will, but every move it makes has psychological consequences. Foreign powers have been irate over the Fed's deliberate inflating policy. At its outset, QE2 generated "a chorus of criticism" from China, Russia, Japan, Brazil and Germany. It prompted one of China's three credit rating services to lower its rating on U.S. debt from AA to A+, on the basis that QE2 is a scheme to defraud the Treasury's creditors.

(Inflation is a scheme to rob everyone.) Whether or not that rating decision was politically motivated, it represents foreign resistance to the Fed's machinations. On November 11, President Obama was politely challenged and rebuffed at the trade meeting in Seoul, mostly because of QE2. The G-20 summit meeting in Seoul was said to have put world powers "on the brink of a trade war" because "other countries are irate over the Federal Reserve's...reckless and selfish scheme to flood markets with dollars...." (AP, 11/12)

The Fed is encountering resistance domestically as well. Last November, Tea Party figurehead Sarah Palin publicly called on Bernanke to "cease and desist" his debt monetization program. (NYT, 11/8) On November 15, conservative economists, academics and former Fed and government officials posted an "Open Letter to Ben Bernanke" calling on the Fed to abandon QE2. Flash forward to this week, when Congressman Ron Paul put the Fed Chairman on the defensive by grilling him with questions about gold. Aside from the most virulent Keynesians, even the left has begun to distrust the Fed. Robert McTeer, former president of the Dallas Fed, said, "What populists on the right and the left have in common is a distrust of the establishment, and to them the Fed personifies the establishment." (NYT, 11/15) Speaking of populism, even the man on the street is starting to catch on:

‘I Can't Eat an iPad' -- The Federal Reserve bombs in Queens.
The Federal Reserve has been on a media campaign to sell its monetary policy to average Americans, but this hasn't always gone smoothly. Witness last week's visit to Queens, New York, by New York Fed President William Dudley, who got a street-corner education in the cost of living.

The former Goldman Sachs chief economist gave a speech explaining the economy's progress and the Fed's successes, but come question time the main thing the crowd wanted to know was why they're paying so much more for food and gas. Keep in mind the Fed doesn't think food and gas prices matter to its policy calculations because they aren't part of "core" inflation.

So Mr. Dudley tried to explain that other prices are falling. "Today you can buy an iPad 2 that costs the same as an iPad 1 that is twice as powerful," he said. "You have to look at the prices of all things." Reuters reports that this "prompted guffaws and widespread murmuring from the audience," with someone quipping, "I can't eat an iPad." Another attendee asked, "When was the last time, sir, that you went grocery shopping?"

Mr. Dudley has been one of the leading proponents of negative real interest rates and quantitative easing, so this common-man razzing is a case of rough justice. If Mr. Dudley were wise, he'd take it to heart and understand that Americans aren't buying the Fed's line that rising commodity prices are no big deal. Unlike banks and hedge funds, they can't borrow at near-zero interest rates, and most of them don't have big stock portfolios. Wall Street and Congress may love the Fed's free-money policy, but Mr. Dudley and Chairman Ben Bernanke ought to worry about losing the confidence of the middle class. (WSJ, 3/15)

Our socionomic thesis has been that social mood is ultimately in charge of monetary policy in a debt-based monetary system. We have also predicted that, on the heels of a declining social mood, the Fed would become unpopular, so unpopular that it might eventually be abolished. No other school of thought suggested these developments back when the Fed was revered. But hints of the new trend have been emerging ever since. We have also said that Bernanke's latest idea of hosting town-hall-like meetings with the press will prove to be a disaster once the stock market starts falling again. In the end, the Fed will not be able to withstand the onslaught of criticism; it will cave in to the forces of negative social mood, and deflation will win.

The Fed Is Encountering Internal Resistance
It is not just outsiders who criticize the Fed's policies. Kansas City Federal Reserve Bank President Thomas Hoenig voted against all seven of the Fed's policy decisions in 2010. He disagreed with QE2 on the basis that it would generate inflation. He went public with his views at a Republican meeting in Washington on December 2. Richmond Fed President Jeffrey Lacker and Philadelphia Fed President Charles Plosser have also expressed concerns. Even Kevin Warsh, at that time a Fed governor-at-large who had never failed to support Bernanke, in a New York speech "warned of ‘significant risks' associated with the program" (AP, 11/9) and expressed doubt that it would help the economy at all. His op-ed piece for The New York Times "expressed deep skepticism" of the plan. Richard Fisher, president of the Dallas Fed, in a San Antonio speech called QE2 the "wrong medicine" for the economy. He predicted, "I could envision such action would lead to a declining dollar, encourage further speculation, provoke commodity hoarding, accelerate the transfer of wealth from the deliberate saver and the unfortunate, and possibly place at risk the stature and independence of the Fed." (Bloomberg, 11/9) With the cooperation of a rising social mood, he was right on nearly all counts: The dollar fell, speculation increased, commodities rose, and wealth was transferred from innocents to connected interests. Whether the Fed is risking its independence remains to be seen, but we suspect that when social mood turns decisively negative and the Fed's stature wanes, Congress will become unable to resist the impulse to start ordering it around.

Because the economy has held up, disagreement has abated a bit. But when the trend in social mood turns down again, dissension will increase. The Fed is fracturing internally, and its power to inflate at will faces serious future resistance.

The Fed Is Losing Credibility
In 1999, then Fed Chairman Greenspan was revered like no other man west of the Pope. He even made the cover of Time magazine along with the Treasury Secretary and the Deputy Treasury Secretary under the title, "Committee To Save the World." Chairman Bernanke enjoyed an echo of that prestige at the end of 2009 when Time magazine dubbed him "Person of the Year." Today, however, more and more people view the same authorities as the Committee to Ruin the World. The Fed Chairman is being increasingly criticized, and the Fed's policies and acumen are being increasingly ridiculed. Recent media reports have derided QE2 as a failure. Pundits have calculated that the jobs "created" by QE2 cost about $800,000 apiece. You have probably seen this video: http://www.creditwritedowns.com/2010/11/video-quantitative-easing-explained.html/, which is another example of how respect for the Fed is turning to derision. Without credibility (forget reverence), the Fed will have difficulty enacting inflationary policies.

Authorities Are Squeezing Banks
Talk to any banker and you will hear, "The FDIC is making things worse." Banks are terrified to lend for fear of breaking a rule, and marginal banks are racing to unload their debt portfolios to get some money on the books. Fear of intense oversight has helped bring bank lending to a near standstill. The FDIC has begun suing former bank officials that it believes committed fraud. (Never mind that Congress' very creation of the FDIC ensured recklessness and fraud as ultimate results.) At least partly to avoid the risk that would encourage the FDIC's disfavor, banks are no longer lending to commercial enterprises but instead keeping their money at the Fed or lending it to the federal government.

Banks have long raked in huge profits by charging vendors a percentage of sales on their credit and debit cards. But that source of revenue is being curtailed by law:

"As part of financial system reforms Congress adopted last year, the Federal Reserve Board was required to draw up rules that limit to about 12 cents what banks can charge retailers for every debit card transaction they process, no matter the size of the purchase. Banks now collect 44 cents on average." (USA, 6/9)

If the government wants higher home prices and more inflation, why would Congress slash the profits of banks, which are a major engine of credit inflation? Do you think angry constituents had anything to do with it? Anger against banks is deflationary.

The screws are tightening overseas as well:

"Last year, an international coalition of governments agreed to raise the reserve ratio -- the percentage of what a bank has lent out that it does not owe to someone else, such as a depositor or bondholder -- from 2% to 7%." (USA, 7/6)

Falling reserve requirements fostered inflation; so, what will rising reserve requirements bring? When governments worldwide agree to raise reserve requirements, they are curtailing inflation. As you can see, they can't help themselves. They are getting more conservative, in line with the long term reversal in social mood from historically high optimism.

The European Banking Establishment Is Beginning to Lose Faith in the System
We often hear that central banks can just print money to avoid governments' problems. Here are some excerpts from recent articles on Europe (WSJ, 7/13 unless otherwise marked), followed by some appropriately reverent comments:

"Spain, pronounced cured last month from Europe's debt virus, is suffering a relapse. [Nevertheless,] European officials call the aid package they're preparing for Portugal the final chapter of a crisis that began more than a year ago." (Bloomberg, 4/28)

Monetary authorities are supposed to be curing crises with their loan policies, right? That's what they keep saying, but the end has yet to appear, and every "cure" is followed by another crisis. Inflation would cure the problem, if they could generate it. Two months later, the latest "final chapter" wasn't final:

"Portugal's implosion ended the taboo against European authorities intervening in national politics. With the crisis triggering early elections, the euro area and IMF forced both main parties to sign up to budget cuts in the heat of the campaign as a condition for 78 billion euros in loans." (Bloomberg, 6/22)

So, the EU and the IMF want governments to cut their budgets, to spend less? Isn't a major engine of inflation government spending? Don't the authorities want inflation?

"Greece is being kept financially afloat by a 110 billion euro ($157 billion) package of bailout loans granted by other eurozone countries and the International Monetary Fund last year, and has implemented strict austerity measures in return." (AP, 6/22)

Bailout loans? Why not just print the money?

"But the country has struggled to meet its targets, missing many, and now is in negotiations for a second bailout, which Papandreou has said will be roughly the same size as the first." (AP. 6/22)

Second purse, same as the first! Either this will go on forever, or it will stop, and when it stops, the debt will collapse, the value of people's savings will plummet, and that's deflation. From an EWT reader: "The ECB said that the European banks had to make their Greek ‘explosure' clear. They meant exposure. Quite the Freudian slip!"

"Reform fatigue is visible in the streets of Athens, Madrid and elsewhere, and so is the support fatigue in some of our member states." (Bloomberg, 6/22)

So, people in some nations want their government to default, turning billions of dollars worth of assets to vapor. And people in other nations want their government to stop supporting the nations that are nearing default. If either side, much less both sides, gets its way, won't that be deflationary?

"STOCKHOLM – Saab's owner said Thursday it doesn't have the money to pay employees' wages, deepening the financial crisis that is pushing the struggling Swedish brand ever closer to ruin." (AP, 6/23)

We keep hearing that money is flying all over the place. How could a nation's major car company reach the point where its coffers are empty?

"The International Capital Market Association, or ICMA, is examining whether banks have been improperly exaggerating the amounts of investor demand they are seeing in certain bond sales, including for debt issued by European governments."

Why would banks need to deceive investors into buying government debt if all these governments had to do in order to pay interest was to print money?

"Some banks recently have been reining in some cross-border lending to companies in countries like Spain and Italy....Overall, European banks appear to be growing increasingly wary of lending to each other, even on a short-term basis."

If money is easy and the central banks are fully accommodating, why are banks becoming afraid to lend to each other?

"Banks also are increasing their use of credit-default swaps as protection against their holdings of sovereign debt from shaky countries."

If runaway inflation and bailouts are inevitable, why would banks buy CDSs? (By the way, if a deflationary crash is coming, they won't work. CDS issuers will default. There is no way out.)

"Although the European debt crisis has been dragging on for roughly a year and a half, it appears to have entered a new, more perilous, stage this week."

How is this possible, if central banks are just money-printing machines and banks their happy beneficiaries?

"The moves reflect mounting concern that Europe's political leaders lack the will to adequately address the Continent's problems."

As we have predicted: when social mood declines, people get conservative. The best laid plans will fail in the face of an angry mob.

"Italy surprisingly has the third largest debt market in the world with more than $2.2 trillion in debt. In fact, Italy's debt market is larger than that of Spain, Greece, Portugal, and Ireland combined." (Bianco, 7/11)

So? Why doesn't Italy just print money to pay the interest? What's the problem?

"An official at another bank said the situation in Italy is being monitored ‘moment by moment.'"

That's reassuring. It reminds me (see The Wave Principle of Human Social Behavior, p.367) of the Asian financial crisis in 1998, when President Clinton was on the phone 'round the clock with the Plunge Protection Team, one of whose members was out west fly-fishing. What they were doing? Trying to figure out what to do. Sounds like now.

"two relatively healthy European banks said they recently have been attracting more short-term deposits, despite the fact that they are offering ultra-low interest rates."

If inflation were raging, wouldn't a zero-interest account be the worst possible investment?

"The officials said the uptick in deposits is indicative of a flight to safety."

No doubt, but if inflation were roaring, a non-interest-bearing bank account would be the complete opposite of "safety." If this behavior surprises you, you have been reading too much inflation literature.

European Creditors Beware

"Bank of Ireland Plc will seek to impose losses of as much as 90 percent on 2.6 billion euros ($3.7 billion) of subordinated debt as it offers bondholders an exchange for cash or equity. ‘We were expecting the terms of the offer to be bad, but this is worse than expected'.... (Bloomberg, 5/31)

How can this bank not have the money? Isn't the world awash in money? Why doesn't the European Central Bank just print it? Could it get worse? Read on:

"If the debt exchange offers ‘fail to deliver the expected core Tier 1 capital gains to each of the banks,' the government will take ‘whatever steps are necessary' under new laws introduced last year ‘to ensure that burden sharing is achieved.'" (Bloomberg, 5/31)

Burden sharing? Aren't the all-powerful central banks supposed to be able to lift all our burdens through QE?

"Adding to the jitters, Moody's Investors Service on Tuesday cut Ireland's credit rating to high-yield, or ‘junk,' status."

If Ireland can simply inflate, what's the worry? All it need do is print new money to pay the interest, right? Apparently, that's not right. But wait. The IMF has a solution for troubled banks:

"It is...imperative that weak banks raise capital to avoid a pernicious cycle of deleveraging, weak credit growth, and falling asset prices." (Reuters, 4/13)

Translation: "It is imperative that banks with no assets get new assets from a system in which assets are disappearing and values are falling." Sounds like a plan.

One leader who lived through a debt collapse did not mince words. In a recent commentary Mario I. Blejer, former central-bank governor of Argentina, offered the following assessment of Europe's troubles (Bloomberg, 5/30 and 5/31):

"One of the undeniable features of the European debt crisis is the tendency to obscure, verbally and politically, the real issues at play. Euphemisms, statistical gimmicks, meaningless institutional squabbling, undecipherable acronyms, and plain double talk proliferate as part of the debate."

Let's not bicker and argue over 'oo owes 'oo. Inflation will bail everyone out, right? Apparently not:

"there is no long-term stable solution without debt relief, which, in plain English, means default. There are many ways of defaulting, but it is evident that without a significant haircut for bond investors there is no way out. The real question isn't whether, but when and how."

Sounds like Ludwig von Mises! (The original guy, not his interpreters.) But wait. Can't governments just pledge public money to bail everyone out? I guess not:

"The pyramid may continue to grow for a while, particularly if the cement used is public funds. But it is an unstable construction because European bailouts are becoming politically questionable and because throwing International Monetary Fund money into the Ponzi scheme is raising objections. This strategy is only making the situation worse."

Raising objections? It sounds as if authorities may not be fully free to wave a wand and cure all bad debts. Politically questionable? This sounds like the animal spirits problem. And animal spirits are regulated by waves of social mood. Who let these ideas in the door?

Well, you say, these comments are from a retired central banker. Nobody currently in a position of power would say it. But guess who said the following:

"Insolvent banks and financial institutions must be shut down, purging insolvency from the system. We must restore the market principle of freedom to fail. If some banks are recapitalized with taxpayer money, taxpayers should get ownership stakes in return, and the entire board should be kicked out. But before any such taxpayer participation can be contemplated, it is essential to first apply big haircuts to bondholders." (Op Ed, WSJ, 5/9)

Answer: Timo Soini, chairman of the True Finn Party in Finland. Wow, a major politician other than Ron Paul calling for failure and default instead of bailouts! If this kind of thing catches on, maybe hyperinflation won't turn out to be the problem.

Could the same thing happen in the United States and all over the world? Hedge fund manager Paul Singer thinks so:

"right now the system ‘is underwritten by the United States government and the governments of Europe. And the system is perceived as underwritten or guaranteed. [But] at some point that guarantee, in some way that I can't really visualize today, will go away.'" (qtd in WSJ, 3/19)

This is a radical statement right in line with the thesis in Conquer the Crash. Almost no one seems to be able to visualize a deflationary collapse, with impotent governments and central banks standing by and letting it happen. But in the end, this is the likely scenario.

Could European Debt Implosion Affect the Value of U.S. Savings?
I'll bet you didn't know this:

"U.S. regulators are worried about the "systemic risk" posed by the exposure of American money-market funds to European bank debt." (WSJ, 6/27)

Some economists wanted to count money-market funds as part of the "money supply." But are these funds really just IOUs for money, not actual money? It seems so:

"now we learn that since 2008 U.S. money funds have been allowed to pile into European bank debt even as everyone knew those banks had stocked up on bad European sovereign paper. Half the assets in U.S. prime money market funds were invested in European banks as of the end of May....The Treasury is even saying privately that the U.S. needs to support the European bailout of Greece lest European banks fail, U.S. funds take big losses, and we get another flight from money funds." (WSJ, 6/27)

Money (real money, anyway) can't be defaulted upon. But "money funds" can be. Why are investors in these funds so complacent? Maybe it's because they believe in an all-powerful Fed that will bail out the world with unceasing inflation.

Trouble for the Asian Leader, Too
Read what financial rating service Moody's has to say about Japan:

"[There is] a weakening in the government of Japan's creditworthiness. [We anticipate] a potential reduction in the likelihood that the Japanese government would support Japanese banks, in case of need." (Moody's, May 31)

Not possible! All Japan has to do to help its banks is to print money, right? Does Moody's mean to say that a government might choose not to bail out its country's banks? Why wouldn't it just fire up the helicopters? Could there be something wrong with Bernanke's helicopter analogy?

Falling Collateral Values and Resulting Fallout
More available credit drives up house prices, and rising house values serve as collateral for more credit. Less available credit reduces house prices, and falling house prices reduce the value of collateral available for backing credit. Credit agencies created or supported by government plumbed the depths of the housing market in the early 2000s, ultimately lending as much as 105% of house values for collateral loans. When the reversal occurred, there was virtually no one left who qualified to buy a house. Creditors never saw the reversal coming, and now they are stuck with bad mortgages. They are too afraid to finance more of them, and even when they do seek new buyers, they can hardly find them because they've been used up. That's why we keep reading reports like this:

Home prices fell in more than three-fourths of U.S. cities in the first quarter as foreclosures that sell at cut-rate prices devalued real estate." (Bloomberg, 5/10)

"Nearly 23% of mortgages are underwater...." (WSJ, 6/27)

Cut-rate prices? Mortgages underwater? How can these things happen despite record QEs from the Fed? Shouldn't house prices be racing upward, and rising above the value of the mortgages? Apparently not, and the trend is affecting the health of U.S. banks:

"The number of banks at risk of failing made up nearly 12 percent of all federally insured banks in the first three months of 2011, the highest level in 18 years." (AP, 5/24)

QE-driven inflation was supposed to cure all these banks, but it seems that real estate prices are falling anyway, as bank credit deflates. The problem is that most of the loans in the world are backed by the world itself, i.e. property, and property became historically overvalued thanks to an excess of credit. Falling property prices create fear among bankers:

"Banks, for their part, are hoarding cash, being stingy with new loans." (WSJ, 6/27)

"Average loans among the largest banks fell 6 percent in the first quarter from last year." (Bloomberg, 4/25)

Why aren't banks lending their depreciating money out at enough interest to overcome value destruction from inflation? Wasn't that the Fed's plan? If so, it's not working. Fear is more powerful than levers. There is investment fallout, too:

"Loans still make up half of bank revenues and loan growth is negative... We have spent the last few weeks on the road visiting investors. The overwhelming feedback on banks has been ‘Why bother?''" (as qtd. in Bloomberg, 4/25)

Why aren't investors interested in institutions that are direct beneficiaries of the Fed's easy money policies? Is debt deflation more powerful than the Fed?

It's not just deflation, either; it's all the other problems that the historic peak in optimism generated. For example, the fancy debt packages that financial engineers built, where mortgage packages were divided into "tranches," clouded the issue of who owns each house. Banks trying to foreclose began taking shortcuts in the paperwork to get at the property. Finally, lawyers realized the problem and brought the foreclosure process into courtrooms, where all progress goes to die. Moratoriums, reviews, challenges and lawsuits are gumming up the works. Tens of thousands of homes are now in limbo, with occupants paying no rent, banks stuck with legal expenses and creditors holding paper of even less value. Situations such as this discourage the lending process, which crimps inflation.

Insurance Companies Will Soon Be Pressed to the Wall

"The private insurers that cover $700 billion of U.S. mortgages are facing an onslaught of foreclosures. Private mortgage insurance covers the first 25% of a mortgage's value against default, plus accrued interest. But the three big monoline insurers -- MGIC, Radian and PMI, which comprise 60% of the industry, according to research outfit Inside Mortgage -- appear woefully undercapitalized to meet the claims that loom over the next couple of years." (Barron's, 6/27)

Undercapitalized means they don't have enough money. How can lack of money be the problem when the Fed is printing money like crazy? And, if insurers go under, so that even insured mortgages fail, what will houses be worth then? Less than today? How can that be, if inflation is raging?

"In fact, there's a distinct possibility that the coming avalanche could more than wipe out the three companies' shareholder equity, with no new sources of capital available." (Barron's, 6/27)

It seems incongruous for companies to worry about new sources of capital when everyone is supposed to be flush with newly printed cash, fresh from the Fed. Wiping out shareholders' equity won't be inflationary, that's for sure.

Rats Are Leaving the Sinking Ships

Shares of Regions Financial Corp. opened lower by nearly 5% Tuesday after the company said its chief risk officer has resigned. Additionally, the firm said its director of credit risk has retired, while the head of problem asset management has left the company. (MarketWatch, 11/16)

The guys who operated the inflationary credit mills are turning over the reins and getting out of Dodge. As the crisis resumes, look for an exodus of insurance company executives and pension fund managers, too.

Twilight of the Financial Engineers
The European Union was supposed to unite Europe by providing a common currency and a lender of last resort, the European Central Bank. Lenders of last resort are a folly. All they do is ensure a system-wide crash. When there is no lender of last resort, depositors and bankers have to behave prudently. In a free market, if they were to act imprudently, their competitors would take away their depositors and clients. When there is a lender of last resort, everyone is encouraged to act imprudently until the credit system fails. A recent opinion piece on Bloomberg said, "The euro has turned into a bankruptcy machine." (Bloomberg, 11/16) Iceland collapsed, Greece is imploding, Ireland is failing, Spain and Portugal are on the brink, Italy and Latvia are weak, and Germany and Finland are fed up. And Europe is not isolated. When the world is loaded with debt, the failure of any major sector imperils everyone. It's like an unsecured mountain climbing chain. If one guy falls off the ledge, everyone is going down.

Within the next few years, after every authoritarian trick is exhausted, the supposed infinite powers of central banks to inflate and of their governments to spend are going to melt like ice cream in the sun. In the end, the Keynesians and monetarists, the great macro-financial engineers of the 20th century, will be discredited. We can only hope that it will be enough to relegate their theories to the ash dump of history.