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John Bolton questions whether the current monetary system will survive these days of high debt, weak inflation & low interest rates

John Bolton questions whether the current monetary system will survive these days of high debt, weak inflation & low interest rates

By John Bolton*

You've no doubt heard the expression before so let’s start by defining it. Fiat money is paper money that comes into existence by government law. It is not valued to any ‘objective standard’ to say a commodity like gold or silver, so governments can produce as much money as they like. When you hear the expression ‘printing money’ that’s what is being referred to.

The widely held view amongst economists is that if you increase money supply too much you get high inflation. So the theory goes, but in practice this time it’s playing out different. The increase in money supply has poured into assets like shares and real estate causing a massive rise in asset price (but this isn’t considered inflation.) It has not translated into general goods and services. 

I think the length of time we’ve had in this low rate environment is worrying. It feels like we have adapted to, and almost become dependent on, low rates. There’s a risk that we can’t break the shackles without serious consequences.

House prices cannot increase faster than economic growth indefinitely. Increasing leverage and external capital (creating money) are the only two things that drive house price growth above economic growth. The main driver over the past two decades has been leverage which is both constrained and constraining. 

With Kiwis owing over $200 billion in residential mortgages it wont take much of an increase in interest rates to constrain consumer spending. We’re also running out of capacity to borrow more even at low interest rates. 

Low mortgage rates 'our economic meth'

As borrowers low mortgage rates are exciting and are broadcast as ‘headline news.’ It has become our economic ‘meth’ and it blindsides us to the wider long term consequences. How often are you hearing that we’ll be ok because interest rates can stay low for as long as it takes. What if it always takes until it's too late? 

It is challenging to find a healthy yield on any form of investment, and so in pursuit of yield the markets are mispricing risk. How do we deal with an aging population coming out of the work-force and low yielding income? There is $146 billion in retail bank deposit earning gross interest of 2.50%. A retiree with $1 million in term deposits will earn $26,000 per year after tax. In real terms $15,000 of that is getting eroded by inflation. 

We have all of this printed money pouring into assets like shares, bonds and real estate that is causing no generalised inflation. We then have investors chasing lower and lower yielding (or riskier) assets. We have retirees sitting on a combination of over-inflated assets and low yields. Then those of us working collectively have more debt than during the Global Financial Crisis. 

House of cards anyone?

The final piece of the picture is technology led deflation. We are at the start of a new era of robots and artificial intelligence and exponential technological change. It seems like a lifetime ago but the first smartphone was only launched in 2007. Mobile phones as a category only became commercially available in the mid 1980s. 

Technology is going to have a profound impact on the labour market. Most jobs we have today will not exist in 30 years’ time, and how on earth do we transition an economy through that at the same time as dealing with extraordinarily high debt-levels and asset bubbles?

I have a sneaky suspicion that our current monetary system (and possibly the way governments work) will not survive what’s coming. History shows us that change is inevitable. Is it that time again? Is fiat money coming to an end? 


*John Bolton is the principal at Squirrel Mortgages. This item first appeared here and is used above with permission.

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Actually energy is. ever increasing use of technology requires ever more energy use and implies for ever growth on a finite planet. "Most jobs we have today will not exist in 30 years’ time" yes I agree, but I dont see the same future as you. I see an energy limited, small, local future with a lot less humans in 30 years time, 1.5billion, maybe 2, not 7 or more.

I think you are too pessimistic. Most western countries are already well below replacement rate for births and developing countries are getting there quickly. Electric vehicles are here and renewables are making great strides. NZ in particular has zero energy problems. We have just shuttered a mine with plenty of coal left and we could immediately increase our electricity supply by something like 25% by shuttering Tiwai (not that I'm advocating that).

Yeah agree there is not going to be an energy shortage. Electricity is the energy of the future and it is easy to generate eg nuclear and hydro. We are getting better at storing it and I think in the next 10 years we will solve that problem too.

It's great to be optomistic; but you also have to be realistic...

You need to watch this.


The planet is overpopulated; the growth of war is inevitable... (start investing in non-lethals)

In 2 generations we have killed the planet...
Cooked to death...
Seas turn to acid (killing a massive part of the food chain)
We are at the end of antibiotic era.. death by infection will be incredibly common (to the extent we won't want to go to hospital for what we go routinely for now like hip replacement).

More than 6,000 deaths a year could be caused by a 30% fall in the effectiveness of antibiotics in the US, a report in The Lancet suggests.
It said most of the extra deaths would happen in patients having colorectal surgery, blood cancer chemotherapy and hip replacements.
UK experts said the study confirmed their fears that antibiotic resistance would affect routine surgery.
England's chief medical officer has called the issue a "ticking time bomb".


So by saying 1.5 to 2 Billon people you expect some sort of apocalypse or mass cull of the human race?
In saying that I think that technology will deal to the energy problem as well. I would not be that keen to invest in old generation tech. That includes solar.

1.5 to 2 billion is highly desirable world population. My preference would be less. 7 billion won't work even with the technology.

Absolutely all fiat money "experiments" in history have ended badly.

Money has always been fiat to some extent. Even the so-called silver and gold standards required a sovereign to establish and enforce a standard value of currency.

Money has always been fiat to some extent. Even the so-called silver and gold standards required a sovereign to establish and enforce a standard value of currency.

We are all going to need to lower our standards to live within what we have, or can grow. I can buy a good bicycle with what it costs to service my car.

Great article! What most people fail to realise is that the majority of money in our modern economy is created by commercial banks making loans:
(Note this is an article from the Bank of England not some whacko doomer site.)
As property markets heat up banks create more money (debt) adding further fuel to the fire. Quite why we allow this is not clear to me - and there are many alternatives. Iceland is flirting with the idea of putting all money creation in the hands of their central bank. Steve Keen suggests that mortgages should be limited by the imputed rental return of the property. The big unknown is whether our system will change because of a crisis - as you suggest - or whether we'll see other countries having success with innovations and learn from them. Naturally, I hope for the latter.

The truth is out: money is just an IOU, and the banks are rolling in it

Back in the 1930s, Henry Ford is supposed to have remarked that it was a good thing that most Americans didn't know how banking really works, because if they did, "there'd be a revolution before tomorrow morning".

Well written, easy to understand. I will send my children the link in the hope they read it.

Excellent piece and very important. So the governments have saved the bankers, stockbrokers and bondholders by funnelling the money to them without creating inflation, (as measured by them) the "trickle down never happened.. But now they cannot lift interest rates, or not in this current environment.. so I think you are correct in surmising the only way out of this is the devaluation and eventual destruction of currency and savings. End result will be a messy transition to alternative new currency which will be backed by bonds, shares and assets ... strategy moving forward can only be to pay more for overpriced assets, and hold even if yields are poor?

If you use what "money" you have to purchase something which is just another form of "money" then you are going to lose it all the same when the "money" can no longer be swapped for anything tangible and useful, like food or shelter. Which is why there is a bias toward using it to buy land and buildings. Not risk free as the ChCh experience has shown, but certainly less than shares or financial instruments.

Put 10% of your assets in physical gold as gold is outside the financial system so if the system implodes your covered. Its insurance allows me to sleep at night anyway.

a) only if no one ie the govn knows you have it.

b) Arguably if it gets so bad you need gold and need to use it, lead would have been a better buy, ie by the time our entire financial system has imploded due to "fiat currency" the world will probably look like Mad Max, rather hairy.

I tend to agree with much of this article. Asset crash or fiat collapse are pretty much baked into the pie now. I don't know which way it will go.

Why not both?

"assets" are only worth today based on the return they will provide.

lets do a model, so if you buy an asset at a fair price for $1million and you get 100k / annum return, OK, good. Right now assets seem to be x3 so you have spent $3million for $100k return, not so good. However that return is based on a fossil fuel grow for ever model which is impossible. So that return is going to collapse also probably by 60~75%. "suddenly" that 3million will be getting a return of $30k/annum, who is going to pay you 3million? for such a pathetic return?

We often talk about banks and Fractional Reserve Banking but the economy works exactly the same way.

A bank run is when the people all try to take their money out of the bank at the same time. A bank cannot pay out because it does not have enough money.

When this situation happens elsewhere, say housing, we do not say "A house sale run" we say "The bubble has burst"

Similarly when people all want their money from the bank at the same time we should be saying "The Reserve Bubble Has Burst" or some such similar.

Consider this

An item is only worth what someone is prepared to pay for it.

Based upon that belief we can confidently say “My house, or shares, or whatever, are worth $x”

But that worth drops proportional to the number of people who chose to convert to cash at any given point in time.

Just as a bank does not have sufficient cash to pay all of its depositors at a given point in time neither does the market place.

Put another way

The total value of all the assets in New Zealand (or the world) have a value (in peoples minds) that far exceeds the amount of cash to actually pay the prices people expect. In other words it is the same as Fractional Reserves.

Money in bank = 5% of deposits

Money in the country = 5% of total asset values

If you had ALL of the money in New Zealand it would not be enough to pay the current asking price to buy every single house in New Zealand.

Going back

An item is only worth what someone is prepared to pay for it.

Is really saying an item is only worth what the economy has cash to pay at a given point in time.

If only a fraction of the people wish to sell their house at the same time then there is sufficient cash available to pay the asking price.
As banks keep issuing mortgages they keep injecting more cash into the market allowing house asking prices to rise.
Note what would happen if the banks stopped lending. House prices could not keep going up as there would not be enough cash to pay the asking prices so prices would fall to match the amount of cash available

Value is just a dream, especially when it is attached to a fiat currency

Interesting comment, but one other thing, time is important also. An item is also worth what someone in the future is prepared to or can pay for it. Their ability to pay is based on their future earnings. If their earnings are considerably less in the future (and they will be) then the ppl owning the assets today (say the BBs) are going to find there not only less ppl buying but also not at the price expected. To me this suggests that asset deflation in the order of 60~90% is probable. 90% loss could be down to what you mention, in effect a firesale.