Faustian precedent bodes ill and leaves gold and silver in prime position
Faust Part 2 by Goethe includes a cautionary tale on money printing replacing gold with ultimately dire consequences - alluded to recently by Jens Weidmann. Could this be a warning to all Central Bankers?
Posted: Friday , 21 Sep 2012
Bundesbank President and economist, Jens Weidmann, hasn't exactly kept quiet about his lack of support for the ECB bond-buying program. But this week he put it into a context which the public would be able to understand, and ‘shocked' Europeans by relating the program to that of making a deal with the devil.
Weidmann refers, as many have before him, to the ‘Faustian pact', called so thanks to Act I, Part II of Goethe's 1832 play ‘Faust'. In the play the Devil, Mephisto, convinces the Holy Roman Emperor to print large amounts of paper money rather than use gold. In the short term, the money printing solves the emperor's financial problems, but it soon leads to rampant inflation.
Inflation is an invisible thief, it leads to disposable incomes falling, savings decreasing in value and interest rates becoming effectively detrimental to those who try to be sensible with money.
Whilst Weidmann did not refer to Draghi's, or anyone's money printing exercises, he warned "If a central bank can potentially create unlimited money from nothing, how can it ensure that money is sufficiently scarce to retain its value? ...This temptation certainly exists, and many in monetary history have succumbed to it".
Mr Weidmann of course speaks of his own country's historical experience when the money printing in Weimar Germany led to devastating consequences, something which just about remains in living memory.
Following Mr Weidmann's comments, many are arguing that the economy of the 19th century was quite different to that we have now. Therefore, surely we cannot use such a simple, archaic example to forewarn of dangers in the monetary system today? Well that's most likely what the wise men in Weimar Germany thought as well, and maybe even Gideon Gono, Zimbabwe's reserve Bank Governor during its period of hyperinflation.
If new money could pay off bad debts, then why has no economy in history figured out how to make it work? History told Goethe this wasn't a sensible solution, history since Goethe tells us it isn't a sensible solution, so why do our bankers think they are suddenly all superior?
Easy money, as Mephisto shows, solves problems for the short-term, brings praise for those who action it in the short term, but brings nothing but bad feeling for those same people from those it affected the most.
When launching QE, central banks are very much hoping to set off the ‘wealth effect', low interest rates, higher bank lending - people feel wealthier and so they spend more. However QE doesn't have a proportional response.
QE, or any other technical form of money printing, is a practise which demonstrates the law of diminishing returns, just look at Japan. They've been at it the longest with nothing but stagflation to show for it.
Chris Martenson points out that given the median household income in the US is approximately $50,000 the Fed, by this time next year, will have printed up the annual earnings of 9,600,000 households under QE3. Therefore, each time the Fed prints, you have to work even harder the following year in order to recoup the same benefits as that original $50,000 would have made for you.
As Eric Fry over at the Daily Reckoning points out, in the last 4 years the number of Americans on food stamps has increased to 17 million, whilst the number out of work has increased by more than 3 million.
The US, which has embarked on a ‘QE to infinity program' has is headed down an un-trodden road. The US economy is now an experimental economy for which the citizens suffer.
As Nasim Taleb says ‘Quantitative Easing is a transfer of wealth to the rich. It brings up the housing prices. The state is subsidising the rich, it is the top 1 per cent that benefit from QE, not the 99 per cent. QE really is flooding banks with money so they pay themselves bonuses with it. Banks have money and assets so now they can borrow easily. The poor guy here who is unemployed and can't borrow is not going to benefit from QE.'
Late last month, the Bank of England released a report on the ‘Distributional effects of asset purchases'. Somehow, it finds, without proof, that without the Bank's asset purchases ‘most people in the United Kingdom would have been worse off.' It argues that savers and pensioners have been protected from the potential effects of unemployment, company failure and low economic growth. All of which we have, but apparently they're not as bad as they could be.
The media did notice however, how the central bank acknowledges that QE has seen a huge transfer of wealth to the already super rich.
The super-rich love QE, as do the central bankers, and banks. QE provides a huge boost to asset prices. However this does not mean an increase in the value of the assets.
This increase in asset prices is supposed to make everyone feel wealthier. So whilst those savers and pensioners might be being screwed over by the negative interest rates and a loss in deposit income, they'll still spend more of what little money they have because they ‘feel' wealthier. However whilst inflation may not feel as though it is punishing us now, it punishes past accumulated assets by making them far less valuable.
QE seems to insulate banks from the need to address their problems, it does not allow for a self-sustained recovery. Japan demonstrates this in full. The BoJ just keep printing money whilst the people feel the full effects.
We might not be able to perform an exorcism on the economy, but we are able to on our own finances. It's time we showed we're not ready to make a pact with the devil but instead can protect our finances from this Faustian pact of which we are not a part.
What is the monetary system which the devil persuades the Emperor to leave? As noted above, one based on gold. Ironically, the only way to gain ‘operational wealth' during a mass money printing session, as we are seeing now, is to buy and hold gold and silver.
*Jan Skoyles is Head of Research at The Real Asset Company - www.therealasset.co.uk