Q&A with Detlev Schlichter (Part 1 of 2)
2011-AUG-30
You have a book coming out later this year titled Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown (John Wiley & Sons). Given man’s timeless propensity to always seek “a free lunch”, do you think that there is a historical inevitability about our current debt problems?
Detlev: I don’t believe that history takes a predetermined path. Nothing is inevitable in human history. We make choices – but then we have to take the consequences. Our current debt problems are the inevitable consequence of the decision to give up the gold standard and adopt a system of constantly expanding paper money that allows artificially low interest rates – that is, lower than justified by available savings – and credit creation backed by money printing. Such a system must ultimately lead to the dislocations that plague us today – and that was indeed inevitable. The present system is not only suboptimal. It is unsustainable.
What events during your career in the City led you to the view that our current monetary system was living on borrowed time? Was there a watershed event that made you realise that “the emperor had no clothes”?
Detlev: More than any event, it was good theory that convinced me. Over the years, I came to understand and fully appreciate the “Austrian School of Economics”, in particular the work of Ludwig von Mises. Without good theory, events are just random occurrences, and we are unable to understand their true meaning, or what the drivers behind them are. Proper understanding requires theory, not just experience. But I remember certain events that opened my eyes to the extent to which our system had already become distorted. One was Greenspan’s decision in 1998 to cut rates when the hedge fund LTCM collapsed. This was proof that the central bank had become the lender of first resort – even under the leadership of a man who had previously been an advocate of the gold standard, and who had warned of ‘irrational exuberance’. More recently, it was the policy response after Lehman Brothers. Since the Lehman collapse it is clear to me that the money-induced dislocations have become so big that a market-driven liquidation of these imbalances is now deemed politically unacceptable. Hence, we will get ever more money creation by the central banks. This will lead to disaster.
What historical examples of hyperinflation and paper money collapse do you think are a good match for the problems currently facing America, Britain, and other developed nations?
Detlev: In my book I have a short chapter on the history of paper money systems – a history of failure. I focus on the similarities: All paper money systems are creations of the state, not the market. After some time, they all experience economic instability and rising inflation. And all of them end either by a timely return to hard commodity money before total collapse occurs, or in a total currency catastrophe. These patterns are identical. Beyond that, each case is unique in many ways, and our current system, too, has many specific features, among them its global nature and the much larger role of banks. In our system it appears unlikely to me that a timely return to hard money will be achieved. I see neither sufficient appreciation of the underlying problems by the policy establishment, nor do I see the resolve to turn things around.
Why are so many seemingly well-informed economists and financial analysts dismissive of your warnings? Why were many of these same economists and analysts so surprised by the sub-prime meltdown of 2008?
Detlev: Somebody has called this normalcy-bias. We have a tendency to assume that the system we are operating in will remain unchanged. What is will stay the way it is. Sometimes that is a useful assumption, sometimes not. Additionally, the people who work in financial markets need to collaborate and they need to communicate with one another. That is easier if everybody uses the same type of theories, the same intellectual tools to analyze markets and to debate economic phenomena. This has created an intellectual bubble in which large sections of the financial markets operate today. A certain subset of economic ideas – some Keynesian, some Monetarist – now forms the standard paradigm that everybody uses. Then there is the problem that people do not see what they do not want to see, what is a threat to their business. In all fairness, this is why I, too, was slow to appreciate the implications of what happened in sub-prime in 2007. Although my “Austrian School” education should have prepared me, my attachment to the business I was involved in at the time made me not wanting to see what should have been obvious.
Since the crisis of 2008, debate has raged between “inflationists” and “deflationists” – with the former predicting serious inflation as a consequence of central banks’ money printing efforts, and the latter saying that falling prices were an inevitability given the massive contraction in private lending. With even the US government’s heavily massaged inflation statistics now showing US CPI at 3.6% and rising, do you think the inflationists have been proven right?
Detlev: The two groups look at different things in my view. Given the accumulated imbalances of decades of easy money, market forces are indeed pointing toward deflation. If the market were left alone, we would get balance sheet contraction, default and credit contraction. That is what the deflationists see. What most of them do not appreciate, however, is that this is a necessary and ultimately unavoidable development, even though it is painful: a cleansing of the economy of its dislocations. The inflationists look at the stance of monetary policy, which is undoubtedly highly expansionary – and is now feeding through to inflation statistics. I think the endgame will be inflation, not because of what the central banks have done so far in terms of money creation but because of the position they have maneuvered themselves into. They try to postpone the liquidation of capital misallocations at all cost. Their money printing must, however, add to additional capital misallocations, which will require more money printing in thefuture. Ultimately, this will undermine the trust in paper money – and when this occurs inflation will really shoot up.
Part 2 of this interview will be published tomorrow.
Author: The GoldMoney News Des
