The worldwide economy runs on a Post-Bretton Woods concept of money. Central banks create enough new currency out of thin air to provide adequate money velocity. This new money is then inserted into the banking system that then lends it out according to the public’s credit potential to pay it back with interest. The public then multiplies money through purchases of goods and services that create economic output and that redistribute currency back into banks for relending to other members of the public who demonstrate a viable ability to repay.
When an economic shock stalls the money engine, it must be restarted while the economy is on a glide path prior to freefall. When money supply is temporarily pulled from the economy, loan creation that multiplies money is temporarily halted, shrinking the supply of money required to pay back existing loans. When this occurs, although the public still has the skills required to create value to pay back loans, it loses access to money to repay the loans.
If temporary money supply disruption is allowed to fester, enough unpaid debt cycles accumulate to create collapsing credit, toxic debt, shrinking money supply and deteriorating markets. When the economy stalls, one of two government interventions must occur to reverse the trend and right the world’s money growth. Either credit limits must be loosened to allow for borrowing to cover unpaid debt plus future growth, or demand must be increased to create enough credit under existing credit conditions to cover unpaid debt plus future growth. Which process is most viable depends on the extent to which the markets have been allowed to fester.
In the first days of the Great Recession, banks knee jerked in response to collapsing real estate and slammed the credit market shut. Worldwide central banks quickly responded by attempting the first of two interventionist tools. By infusing currency from thin air, they hoped to provide cover for free-falling real estate prices, and to re-establish credit into the market. Had banks re-established loose credit, businesses would have bet on an increasing economy and would have used the new credit to increase production, thereby maintaining employment and multiplying money. However, the toxic asset load from the housing Ponzi was of such historic proportions that central bank loans did not repair bank balance sheets enough to incentivize re-establishment of credit. Without forgiving insolvent bank debts that would have correspondingly collapsed the world’s money supply and depressed world markets, governments indefinitely stalled the traditional banking engine of money growth.
Each month that banks remained functionally insolvent, increased business risk. As money supply collapsed, demand decreased correspondingly decreasing the willingness of businesses to bet on producing supply before demand. When the risk chasm became too great, the economy stalled and then collapsed.
Government Keynesian central planners then attempted a correction through the second of their interventionist tools. However, the stimulus packages they devised to attempt to bridge the demand gap created artificial demand in too concentrated pockets of industry and created too small an artificial demand to restart an economic engine that requires the credit and faith of every able consumer, worker and business in the world pulling on the ropes of credit derived money multiplication.
Both traditional methods of reversing money collapse, central Keynesian planning and central bank capital infusion, proved ineffective. Without effective worldwide government and central banking tools, festering turned parts of the world’s economy gangrene. No single government had the ability to re-start the world’s engine, and no worldwide consensus of political will existed to simultaneously and aggressively create the size of artificial stimulus required.
In desperation, the United States Federal Reserve has embarked on an unrealistic attempt to float the entire world’s money collapse by inflating the world’s Post-Bretton Woods reserve currency through what it coined “Quantitative Easing”. However, any attempt by one country, even the United States, to singlehandedly recover the world’s economy, even with an untried policy as aggressive as quantitative easing, has fluidly dissipated to fill the world’s credit gap without the desired stimulus effect. The temporary momentum created through massive QE creation of dollars out of thin air allowed for a temporary, mild upward glide of the economy, but anticipating the June, 2011 end of QE2, the world adjusted its glide path and its real economy is beginning another freefall.
The Post-Bretton Woods system of worldwide money supply being introduced through fiat currency backed by the simultaneous introduction of credit enhanced value creation has, in effect, been severed. Now that the United States has raced ahead of the world’s traditional money supply, the Fed must either continue down the slippery slope of additional quantitative easing leading ultimately to the collapse of the dollar, or revert to an alternative, non-traditional, never before tried fiscal or monetary tool, to escape from its trap. Any alternative tool will invariably destroy the world’s faith in the dollar as the reserve currency, and will mark the end of the Post-Bretton Woods concept of money.