When the European Stability Mechanism (ESM) was inaugurated Monday, Eurogroup President Jean-Claude Junker could hardly contain his enthusiasm. The ESM, said Junker, will be regarded as "a reassuring presence." In an article published after those statements were made, I noted that there is something quite ironic about calling a rescue fund "reassuring":
"...nothing says 'reassuring' like the need to establish a rescue vehicle to stave-off economic collapse."
The IMF echoed this sentiment in its report on World Economic Output released this week, noting that
"...the euro area crisis has deepened (as evidenced by the fact that) new interventions have been necessary to prevent matters from deteriorating rapidly."
The IMF goes on to cut its forecast for global growth to 3.3% for 2012, the most anemic pace since the financial crisis. More specifically, advanced economies are now expected to grow by only 1.5% this year. The report also contains some interesting figures regarding the odds of recession in various regions:
More alarming than any disappointing projections about global or regional growth however are the IMF's comments regarding central banks and their balance sheets. The IMF indicates that
"...what little momentum exists is coming primarily from central banks."
Nonetheless, it doesn't appear from the report that they view this as anything to be particularly concerned about. In a series of reckless comments, the IMF summarily dismisses the risk of inflation, negative equity, and crises of confidence:
"...no technical reason indicates (inflation is) inevitable. Central banks have more than enough tools to absorb the liquidity they create, including selling the assets they have bought, reverting to traditionally short maturities for refinancing, raising their deposit rates, and selling their own paper. Furthermore, in principle, central bank losses do not matter: their creditors are currency holders and reserve-holding banks; neither can demand to be paid with some other form of money." (emphasis mine)
There are so many things wrong with this passage it is difficult to know where to begin.
First, the idea that the IMF uses the term "technical" in the course of discussing inflation risk is disconcerting. Everyone knows that when you being a sentence with "technically..." you generally are trying to explain why something that probably will happen, shouldn't happen. But it will be no consolation when prices rise to tell currency holders that "technically" this should not be occurring.
Second, as I have discussed at length elsewhere, the tools available (at least in the Fed's case) for liquidity absorption are hopelessly inadequate to soak up the excesses created. Consider for instance the reverse repo option. The Fed will eventually need to extract some $3 trillion to normalize its balance sheet, but reverse repo participants (money market funds and primarily dealers) cannot possibly be expected to fund transactions of this magnitude. The total amount of money market fund reverse repos is only around $500 billion, not even 20% of the capacity needed.
Third, if one moves a few words around, the last statement in the above-cited passage says this:
"...central banks' creditors are currency holders who (cannot) demand to be paid with some other form of money, (therefore) central bank losses do not matter."
There is something inherently wrong with this mentality. It shows no regard for the preservation of currency holders' wealth. Circulating currency (especially the dollar) is supposed to be a store of value. To say that the institutions who print it can make bad investment after bad investment and incur loss after loss simply because the masses cannot demand to be paid in something else is egregious. This is the very definition of moral hazard.
Hilariously, the IMF acknowledges only one limit to central bank balance sheet expansion: silly elected officials.
"Policymakers may falsely perceive central bank balance sheet losses to be damaging to their economies. Such perceptions may make central banks more hesitant to raise interest rates, because doing so would decrease the market value of their asset holdings. The mere appearance of such hesitation may lead private agents to expect an increase in inflation." (emphasis mine)
So according to the IMF, policymakers -- who have been elected to serve the public interest -- would be doing everyone a disservice by expressing their hesitation about the free wheeling debasement of the currency. This is patently absurd.
There are no "false perceptions" at work here. Rising interest rates will decrease the market value of central banks' asset holdings, and if those asset holdings are large enough and rates increase fast enough, the central bank will enter into a state of accounting insolvency (assets less than liabilities). If this doesn't matter then why keep a balance sheet at all? What's the difference?
The difference is that when people lose faith in the legitimacy of the central bank and the currency it prints, all those "technicalities," and "false perceptions" quickly become real inflation and credit markets quickly become really frozen. The IMF's blatant disregard for the wealth of society as represented by its implicit sanctioning of unlimited money printing provides further evidence that the only safe way to preserve wealth is by owning gold (GLD) and other hard assets.