Deflation and Why QE Didn’t Cause Hyper-Inflation
By JC Collins
In previous posts I have postulated that QE was used to facilitate the framework construction of the MFS, or multilateral financial system, which will be emerging between now and 2018. This concept is not an easy one to understand. The first step is to fully understand what QE, or Quantitative Easing really is and how it works.
For our simplified purposes here we will consider QE to be the exchange of low liquidity assets for high liquidity assets. And based on that definition we will clarify liquidity as the ease with which money can be used. As an example, the cash in your wallet and bank account is very liquid, as well as credit cards and lines of credit, they can be used rather quickly in the event you need too. This is considered high liquidity.
An example of low liquidity would be the equity in your home, or other investments and bonds. These assets are not so easy to liquidate into cash and use in the economy. We will mainly discuss low liquidity in terms of bonds.
So QE, or the swapping of assets, and in turn liquidity, were low liquidity bonds which were exchanged for high liquidity assets. A liquidity swap. The Federal Reserve didn’t print money or expand the money supply, because they only “created” money and used that high liquidity to exchange for low liquidity bonds from participating financial institutions.
As such, the balance sheet of the Fed balanced, it was only the composition of the balance sheet that changed. It was the low liquidity to high liquidity ratio that changed. The Fed reduced its exposure to high liquidity assets and increased its exposure to low liquidity assets.
Fortunately the high liquidity assets that the Fed’s QE unleashed didn’t find its way into the regular money supply. I say fortunately because if it did find its way into the lending departments of banks we would have seen a massive expansion of the M1 money supply which would have led to the hyper-inflation that everyone was expecting.
The QE “money” or high liquidity exchanges replaced the low liquidity bonds held by hedge funds, sovereign wealth funds, high net worth investors, and the reserve accounts of central banks around the world. From there some of these high liquidity assets, or instruments, eventually made there way into the capital markets, like the stock market.
So when the financial crisis hit in 2008 there was an overabundance of low liquidity assets sitting on the books of the large financial institutions. These banks and institutions were unable to unload those low liquidity assets into the regular money supply because there was already too much debt in the system.
Quantitative Easing was designed as a method of reducing the risk to these institutions, or transferring the risk back to the Federal Reserve. It’s something of a trick if you will, the Fed simply gave high liquidity assets in exchange for the low liquidity assets held by the banks and institutions. In turn the banks and institutions were not allowed to liquidate those assets into the the regular money supply by way of loans and credit, places from which it could end up in our bank accounts and wallets. That would have caused the hyper-inflation which everyone expected from QE.
This is also the reason why gold and silver have been coming down as opposed to increasing as predicted. Precious metals did not have to account for increases in the money supply because the QE “money” did not end up in the regular money supply where it would have mattered.
QE, through the liquidity swap described above, has reduced the regular money supply which is why gold and silver have been coming down for the last few years. This is also why interest rates have been kept low. The central banks have been holding back rampant deflation by doing so.
As such, with QE now coming to an end, we can expect to see the deflation which has been held back to come on strong and gold and silver will continue their downward spiral.
As deflation settles in over the coming months we will see substantial corrections to the capital markets and stock markets will decrease. The script is already being presented through the media that when the next crisis hits the central banks will be unable to do anything to stave off the collapse, and other banks are insolvent.
This is where we need to focus our understanding for the next stage of the transition to the multilateral financial system.
Central banks have the ability to manipulate the economy by adjusting interest rates at will, which in turn allows them to exert control over inflation and exchange rates. As standard metrics, higher interest rates lead to inflation and a depreciation of currency. Lower interest rates lead to deflation and an increase in the value of currency.
But as we learned above, QE was a method, or bastardization of the two metrics of inflation and deflation, which has caused massive confusion.
Now, because of QE, central banks and other financial institutions around the world are left with low liquidity assets that nobody wants. With the increasing deflation there will be nothing available, no alternative assets, from which liquidity can be increased.
This is where the concept of SDR bonds will be utilized.
The SDR, or Special Drawing Right of the International Monetary Fund, will replace the US dollar as the reserve asset from which this much needed liquidity expansion will come from. The SDR is really three concepts consolidated into one asset.
Firstly, the SDR is a composite reserve asset which was created by the IMF, or the Fund as they call it, in 1969, just before the US dollar went off the gold standard. This is the official description of the SDR from the articles of the Fund.
Secondly, the SDR will act as a new class of reserve asset, becoming tradable as SDR denominated instruments issued by the Fund, or other investment vehicle or institutions backed by the Fund’s members, which has been expanded to include the larger emerging markets, with the Chinese renminbi being added to the SDR composition basket by next year. This has been the purpose for the fast internationalization of the renminbi.
Thirdly, the SDR can act as a unit of account. This SDR will be used to price internationally traded assets, such as sovereign bonds, and goods, such as commodities, like oil and natural gas. It can also be used to peg currencies and to report balance of payment data.
Economic crises are used to further consolidate and integrate regions of the world. The 1998 financial crisis in Asia led to further regional integration, and the 2008 financial crisis was used to implement QE policies and integrate the liquidity framework for the MFS.
As such, today we find that the problems plaguing the international monetary system are as follows:
1. Persistent Global Imbalances
2. Large and Volatile Capital Flows
3. Exchange Rate Fluctuations Which Are Disconnected from Economic Fundamentals, as visible in Vietnam.
4. Insufficient Supply of Safe Global Assets. This is where the SDR bonds will replace the US bonds.
The above items, along with the coming deflation crisis, will be the pretext used to adjust the SDR as described above and begin expanding liquidity by way of SDR denominated financial instruments.
This is the first part of this tale of two metrics. After deflation has set in and the SDR bonds begin to address that specific liquidity crisis we are going to see the next stage of this CSI, or Cultural and Socioeconomic Interception begin. In this stage we will be dealing with the increase in interest rates as inflation begins anew.
With the rising interest rates we will be dealing with a depreciation of currencies. This depreciation is where the third and final characteristic of the SDR will be promoted. A new exchange rate regime will be required which is based upon the SDR’s ability to be used as a unit of account.
The two punch metrics of deflation and currency crisis will lead the world into acceptance of all three conceptual SDR allocations. Through the Basel I, II, and III Regulations on Banking as mandated by the Bank for International Settlements, and the QE policies of the central banks which are regulated by the BIS, the stage has been perfectly arranged for the scripted play which is now about to commence.
Most analysts and alternative media have missed the obviousness of this script because they did not fully understand the nature and intent of QE, or why it would not cause hyper-inflation and lead to dramatic increases in the valuations of precious metals. When massive exchanges of the low liquidity assets held by the central banks begin to be exchanged through substitution accounts for SDR denominated bonds then there will be no denying what has been written here on this site since January.
The big question for Americans to ask is what will happen to the Federal Reserve when another institution exchanges the low liquidity assets on their books for SDR bonds? Who is holding the second largest deposit of US denominated bonds? In the MFS leverage between sovereigns will be balanced. – JC