Martin Armstrong: Two Phases of the Great Depression

http://www.martinarmstrong.org/files/The-Two-Phases-of-the-Great-Depression-5-27-2010.pdf

Interesting read.  It seems to me that we have a race between inflation of the money supply (debt) and collapse of the money supply (debt default).  The fate of the stock market, bonds, and everything else lies in the balance.  Gold benefits either way.  If debt default continues to overpower formation of new debt to replace it, then confidence in governments will collapse as Martin says.  The prices of everything will have to re-adjust to match the available money supply.  This is greater depression.  This is exactly what the bond market would like to see, a strengthening dollar due to scarcity.  The bond market would like to see austerity forced upon every living being to facilitate further bond payments in strengthening currency.  Unfortunately for the bond market, political and social collapse comes along with this scenario and with it outright debt repudiation.

The other horse in the race is inflation of the money supply through more debt creation.  The creators of debt are the government, the Fed, and the banking system.  The banking system has been doing the heavy lifting of massive new money creation (new debt) for many years.  But, this process has been fueled by the ability of business and consumers to take on debt and provide the demand.  This demand has largely disappeared due to debt saturation and the scarcity of available dollars to service principle plus interest payments.  Therefore, the traditional money multiplier of the fraction reserve banking system is not working anymore.  So, all that is left is the Fed and the U.S. government.  They are trying mightily to borrow enough money into existence to kick start the the broken debt machine described above.  So far, it appears they are losing in this effort.  If they can gain some traction, then I agree with Martin that a crash like the great depression is unlikely.  Money supply would expand and alleviate some scarcity pressure in the dollar.  Prices would be supported, including the stock market.

But, there is a huge turd in the bowl.  There really is two methods the Fed and our government can utilize to expand the monetary base, and only one of them is honest and legitimate in the eyes of the bond market.  First, they can borrow the money into existence through the bond market.  This is straight forward and is what we have been doing forever.  The second method is quite another matter and is been called "quantitative easing" among other things.  This is where the Fed buys new U.S. treasuries themselves or swaps things of little or no value for freshly created U.S, dollars.  Of course in either transaction, the dollars required are made on the spot out of thin air.  The measure of quantitative easing can be readily seen by looking at the Fed's "balance sheet." They call it a balance sheet because it theoretically balances assets (dollars) that were created and put into the system.  To reverse this process and clear the liability, the Fed must sell it's balance sheet back to the world in exchange for U.S. dollars, thereby reducing the dollar supply.

The bond market does not like quantitative easing much because it cuts them out of the game and the associated interest payment flow.  Also, conceivably there is no limit to this mechanism to relieve the dollar scarcity issue.  The bond market gets nervous that politicians will feel the heat from their constituency and go to far, creating too many new dollars and devaluing the currency.  To the bond market, this represent risk.  Risk must be hedged in some way.  The way risk is hedged is through higher interest rates.  Higher interest rates lead to higher debt payments and inevitable debt default.

So where does this leave us?  It is clear that the current debt based system is going to fail through massive debt default.  The default will cut the cord to the bond market and from that day forward our new money system will be born.  The default will either occur by a hyperinflation of the money supply though quantitative easing and the ultimate rejection (high interest rates)  by the bond market, or by letting nature takes its course and allow debt to default due to lack of sufficient supply of dollars.  Since the politicians are largely in control of the quantitative easing machine, and if nothing else concerned about their immediate survival, I favor the quantitative easing path to the ultimate failure.

The key is that the result is the same either way, a new monetary system built upon debt repudiation.  That is why I favor Nathan Martin's Freedom's Vision.  It provides a path back to constitutional money that our founding fathers's created and existed for the first 150 years of our history.