Last Tuesday, we noted that Mario Draghi and the European Central Bank were undergoing quite a significant learning experience. Most notably, it became clear that initiating monetary creation is far easier than halting it.
By Thursday, Draghi demonstrated his acumen when he addressed a gathering of business leaders in London. He declared that the ECB would do “whatever it takes to preserve the euro.” What specific measures this entails remain to be seen, but Draghi will have the chance to elaborate during the ECB’s upcoming council meeting.
Regardless of the specifics, the old adage “buy the rumor, sell the news” rang true as global markets reacted positively with an enthusiastic rally. The DOW surged by 207 points on Thursday and added another 190 points on Friday. A recent headline from CNBC proclaimed, “Mario Draghi Just Put a Floor in the Market, Pros Say.”
But what kind of floor is it, really?
It certainly isn’t a robust marble floor firmly established on granite. Instead, it resembles a shaky structure propped up by decaying wooden beams, resting on unstable sediment prone to liquefaction. At any moment, markets could easily break through the cracks below.
Using Adhesive Tape to Control Diarrhea
Without a doubt, Draghi faces a monumental task. He must persuade the world that he can salvage the euro through monetary policy. But what viable options does he actually have?
For starters, he could devalue the currency, which seems to be one of the few paths available to him. In essence, the financial system in the Eurozone is burdened by overwhelming debt, necessitating that Draghi weaken the euro in a bid to provide relief.
His primary aim appears to be inflating the money supply to bail out the banks, alongside managing the interest rates of government debts—particularly for Spain and Italy. But how will he achieve this?
Hopefully, Draghi will shed light on this when he speaks on Thursday. In the meantime, we remain eager and curious about the unorthodox strategies he might propose to further distort credit markets.
Capping interest rates signifies extreme government intervention in markets. To put it simply, it amounts to imposing price controls on money.
According to author and publisher Gary North, U.S. Senator Wallace Bennett explained over half a century ago that price controls equate to “using adhesive tape to control diarrhea.” Senator Bennett may have intended to highlight that such measures are messy and grossly ineffective in achieving their intended goals.
Collective Destruction
No matter how one views the situation, both Draghi and Fed Chairman Ben Bernanke are waging a losing battle. They are attempting to counteract a fragile debt pyramid using digital notations of inflated money—a feat never seen in human history.
In the past, such as during Weimar Germany, currency devaluation required printing presses that operated non-stop. Today, the process is considerably more sophisticated. Money creation is veiled in complexity, and liquidity injections are precisely targeted. Central bankers promote an image of control while navigating the tenuous balance between inflation and deflation.
Nevertheless, this remains a deceptive facade. The value of money is diminished, and savers are ultimately the ones who lose out. In the end, the middle class finds itself hollowed out, much like a coconut. Regrettably, the detrimental repercussions stemming from Western economies’ attempts to wring something from nothing cannot be indefinitely postponed through creative monetary policies.
At this juncture, Draghi and Bernanke appear to be improvising. They lack a coherent strategy, relying instead on instinct as they navigate uncertain waters.
Perhaps there’s a slim chance they will sidestep the financial calamities looming on the horizon. However, the more likely outcome is that their efforts will culminate in collective destruction for both Europe and the United States.
If they cease their interventions now, a widespread default may ensue. Alternatively, if they persist in devaluing the currency, they could delay the inevitable catastrophe until the entire economic system is compromised. Given enough resolve, our money could ultimately become worthless.
Sincerely,
MN Gordon
for Economic Prism