It has long been my opinion that the natural deflation coming from the liquidation of all the malinvestments around the world would be countered by massive money creation from central banks. The pain that would result from a natural, market induced, cleansing of these bad loans would simply be too severe for politicians to tolerate. Instead, I believe that they will continue to run the printing presses in order to inflate away a good portion of these debts and then pay back the rest in devalued currency.
Not only does history tell us that this is the most likely outcome, but we have now started down this road, making the deflationary depression all the more severe. For example, in response to the first wave of deflation that was triggered by the mortgage meltdown of 2008, the US central bank created $7.77 trillion.
We papered over the cracks in 2008 and 2010 with US Dollars, and we will paper over the cracks in 2012 with Euros. In fact, down the line I think it’s even likely that we will paper over the cracks with Special Drawing Rights (SDRs), but that’s another story.
As far as the Eurozone crisis is concerned however, there is one major obstacle to money printing, namely the Bundestag, or German parliament.
The Bundestag, has been, and remains, absolutely resolute in its view that there will be no money printing. They are also dead against the issuance of Eurobonds which would make them collectively liable for losses within the Eurozone. The Bundestag favours fiscal union and austerity rather than a “quick fix” and it’s not hard to see why.
German taxpayers have only just finished paying for the reunification of East and West Germany, and the disastrous hyperinflation in the Weimar Republic in the 1920s is also etched in the German psyche – and many are all to aware of repeating that mistake.
Right now our political leaders are simply buying time, so that they can come up with a way of getting round the fact that Germany is in the driving seat and they don’t want to print. They are doing this by implementing short-term liquidity measures, none of which address the underlying issue of solvency.
One possible way around the Bundestag’s reluctance to print was outlined in November by John Hussman and involves Germany reintroducing the deutschemark alongside the Euro.
“Germany adopts a version of a dual-currency system [the introduction of the deutschemark alongside the Euro] by itself. This is something of a ‘nuclear option’ after failing all other approaches. The benefit of this is that it would effectively allow Germany to issue new debt at negative real interest rates in euro terms, as Germany’s own inflation and exchange rate credibility is greater than that of the euro itself. Indeed, Germany could likely convert its entire stock of euro-denominated debt to deutschemark-denominated debt within about a week, and could legislate DM as legal tender just as quickly. This would also free the ECB to print euros to its heart’s content, without extracting seigniorage from the German people. Meanwhile, Germany could retain any seigniorage from creating new DM. This option would, however, accelerate the depreciation of the euro since a reinstated German mark would be viewed as a safe-haven, much like the Swiss franc. It would also create some difficulty for German companies with long-term contracts having revenues payable in euros, and would sharply narrow Germany’s trade surplus with the rest of Europe. The benefit is that technically, the peripheral European countries would be saved from default. Moreover, Germany could conceivably re-join the common currency on more favorable exchange terms, post-depreciation, so it would not necessarily be the end of the euro.
In short, if you can’t save the euro by restructuring the debt of the weak members, or by having the weak members leave, or by having the fiscal costs fall squarely on the German people, the remaining option is for Germany to leave, inflate the heck out of the euro to deal with the debt problem, and reinstate Germany on post-devaluation terms.”
This is exactly the sort of convoluted workaround I see coming. In any event I believe they will find a way to print because the alternatives are a great deal worse.