The Incomparable Faith of Keynesian Investors

Tea Party Economist

Recently by Gary North: Why the Deflationists’ Argument Is Wrong in Both Theory and Historical Fact


Occasionally, I read something in the mainstream financial media whose degree of delusion takes my breath away. This is such a sentence (August 2, 2012).

U.S stock index futures pointed to a higher open on Wall Street on Thursday, with investors hoping the European Central Bank will signal further measures to aid growth and prevent the euro zone collapsing.

This was published by CNBC, a cable TV network that remains perpetually bullish. It was posted no later than 6 a.m.

Stock futures up: check.

ECB measures to aid growth: check.

Prevent the eurozone from collapsing: check.

“Another day, another avoidance of the collapse of the eurozone.”

Excuse me. A collapse of the eurozone. Is that right? There might be a collapse of the eurozone?

And the ECB may do something to prevent this? Possibly?

Therefore, American stock futures are up. Have I got this right?

Am I to assume that if the ECB fails to take action, that the eurozone could collapse?

Am I also to assume that, tomorrow or next week at the latest, American stock futures would then be down?

We are expected to believe that a collapse of the eurozone is possible. This might mean the destruction of the euro, which would fall to zero value. What could cause that? ECB inflation. This is scenario #1.

On the other hand, there is scenario #2: the collapse of the eurozone might mean the departure of Spain, Italy, and France, which would cease paying euros on their IOUs. That would mean huge losses for commercial banks in every nation, and huge losses for the ECB, which is loaded with these IOUs.

What can prevent the latter? The former. To keep the governments of Spain and Italy solvent, meaning able to make regular interest payments on their IOUs, the ECB must buy their IOUs with newly created euros.

Somehow, the authors of the article implied, and investors seem to believe, that there is a middle path between scenario #1 and scenario #2. So, when Draghi made his unofficial remarks at a pre-Olympic dinner party for the swells, stock market investors grew briefly optimistic. They placed their orders.

The word “collapse” implies a breakdown. It means a major discontinuity. In this case, it means a breakdown in exchanges of euros for goods and services on the continent of Western Europe. It also means the overturning of 15 years of official assurances.

In short, it means a major crisis.

We have now entered the era of official reassurances. The assurances are long gone.


The eurozone is in a permanent state of crisis. It is not going to get out of this crisis anytime soon. The Greek government may pull out of the eurozone this year. This would be good for the eurozone. That morally bankrupt government should never have been allowed to join.

As for Spain and Italy, they may also depart sometime in the next 12 months. What will keep them in is ECB inflation. The ECB will create digital euros and buy the IOUs from these two economically bankrupt nations.

If the ECB can persuade Angela Merkel to persuade the German parliament to fork over a few hundred billion extra euros to keep the governments of Italy and Spain from defaulting on the debts they cannot otherwise pay, the day of reckoning can be delayed.

If Italy and Spain default, this will take down many French banks. If the ECB refuses to bail out France, which will in turn bail out large French banks, France will leave the eurozone and restore to its central bank the right to create fiat money.

That will leave Germany, Finland, the Netherlands, and 10 other nations to keep the euro alive.

Germany would then probably go back to the Bundesbank and the deutschmark. Why stay in a shrunken eurozone?

All this will take time. It will be accompanied by assurances from inside eurozone senior circles that none of this is really happening, that the eurozone will remain intact, and that rumors to the contrary are exaggerated.

As nations depart, representatives of those nations that still remain will say that the recent departure of the others was an aberration. “Nothing to it. Trust us.”

Mario Draghi, formerly of Goldman Sachs and presently the head of the ECB, assured guests at a pre-Olympics gathering of high officials that the ECB will do whatever it takes to hold the eurozone together. That was Wednesday evening. That off-the-cuff remark mobilized investors on Thursday, which pushed up world stock markets. No one asked Draghi what he had in mind that was new. No one asked to hear a summary of his new plan. The other plans had been vague. He has no new plan. He has one vote on the board of an institution that can legally create money out of nothing and buy IOUs with it.

So, it is up to Merkel and Draghi to work out a plan to unify the 17-member eurozone into a national government with a common fiscal program.

Here is the bone of contention. Draghi wants a unified government whose IOUs are issued by all 17 members. This means that Germany and the Netherlands must co-sign the notes issued by the central government. Merkel says she will never consent to this. She has repeatedly made assurances like this. But she has broken them whenever the banking system looked vulnerable.

Draghi wants government-guaranteed bonds with the full faith and credit of the eurozone. This means bonds will be issued with the full faith and credit of Germany. Germany is the paymaster. It always is. Like a rich uncle, Germany attracts ne’er-do-well cousins, who want to be put on the lifetime dole by Germany. They want to borrow from German banks and the German government. They want to avoid paying back principal, which they cannot do apart from hyperinflation. They want ever-larger cuts in interest rates and ever-larger welfare state spending. Aunt Angela is expected to fork over the money.


If Draghi had anything new to offer, he did not explain what it is. He has had a week to do so.

Stocks went up sharply the day after his remark, and they did not fall back for a week. This indicates that the investing world believed that he has a new plan, despite the absence of any evidence. They believed that the great discontinuity – the collapse of the euro – can and will be overcome by means of Draghi’s plan.

What power does the ECB have? The power of money creation. There is no question that the ECB has this power. Just ask Angela Merkel. The ability of the ECB to inflate is the bone of contention between Merkel and Draghi.

The representatives of the comparatively solvent northern nations, which have export-driven economies, favor large trade surpluses. They are upset that the borrowers have borrowed far more than they can repay. Everyone knew that when the loans were made. There is never permanent repayment in a Keynesian, fractionally reserved universe.

Monetized debt cannot be paid back without a 99% contraction of the money supply (with a 1% reserve ratio). The central banks must replace paid-off debts with new ones. This is the ultimate lobster trap of debt. All central bankers have known this ever since at least 1900. Central banks’ purchases of debt create the ultimate economic addiction. The investors believe that this will not happen. They believe that there will be no contraction of the money supply. If there were, this would create a replay of the Great Depression’s first phase, 1930-33. Then it would further contract. Most banks would fail. Almost all IOUs would become worthless. No one could repay. That was why Congress created the FDIC in 1934: to stop the runs on banks, and therefore to stop the contraction of the money supply.

So, the investors believe that the ECB, the Federal Reserve, the Bank of Japan, the People’s Bank of China, and all other central banks will take action, meaning money creation, to prevent any such scenario. But they also believe that there will not be hyperinflation. They believe in a middle path between hyperinflation and Great Depression 2.

So do central bankers. They believe that they can always avoid the two worst extremes. But the only factor preventing hyperinflation today is the unwillingness of commercial banks to lend the Western central banks’ post-2007 monetary bases into circulation, multiplying through the banking system.

This factor could change. The central banks could make it change overnight by imposing fees on excess reserves held at the central banks. There would be a huge economic boom in commodities, but the price of this boom would be runaway consumer prices. That would be proof of defeat for central banks.


On August 2, an hour before the U.S. stock markets opened, he gave a brief speech. He said that the ECB has no fixed plan. This had been the universal assessment of his critics for a week. His comment a week before had been rhetorical, not substantive.

Until he gave that speech, stock markets across Europe were up. Then they all dropped like a stone: straight down. It was as if they had fallen off a cliff. This was at 9 a.m.

Immediately, American stock futures reversed. The note of optimism that had marked the CNBC story at 6 a.m. was gone. Thirty minutes after Draghi’s speech, the Dow Jones Industrial Average opened down over 130 points: 1%.

All of this intra-day trading is neither here nor there in the grand sweep of events. But what happened within just a few minutes indicates the extent of unwarranted faith in Draghi’s words.

The eurozone is headed for many years of trouble, irrespective of Mr. Draghi’s remarks. The ECB is trapped. It dares not inflate to the degree that Germany will pull out of the eurozone. Yet it dares not stabilize the money supply and refuse to buy the bonds issued by PIIGS. It must walk down that middle path.

That investors would respond in wild enthusiasm for one day to an off-the-cuff remarks by Draghi at a gathering of Big Shots indicates the utter credulity of investors.

That any article writer could believe that the euro is headed for a collapse, as distinguished from a slow decline of purchasing power in relation to foreign currencies, indicates that they do not understand monetary policy, nor do they think their readers do.

That either investors or journalists could believe that anything Draghi says is economically significant indicates the extent to which the world’s capitalists and their salaried cheerleaders in the media have faith in central bank monetary inflation. What possible new idea could Draghi have brought to the table on the day the Olympics opened? What had he cleared with other senior members of the ECB? Nothing, as they said before the one-day boom in stocks was over. He had not discussed anything with them.

But what if he had? What if they had all agreed to make an announcement to the media, rather than to a group of famous party attendees? What difference would their announcement have made? None. A committee’s announcement is filled with qualifications and hedges. This is why committees do not get invited to swank dinner parties thrown by senior politicians.

Of course, wild men don’t get invited, either. Peter Schiff is not invited. I’m not invited. Surely Gerald Celente is not invited. Big Shots are afraid of loose cannons as much as they are bored by committee members.


The monetary system grinds on. So do the capital markets. There is no collapse.

But at some point, the ECB senior committee and the Federal Open Market Committee composed of regional central bankers will have to fish or cut bait. They will have to inflate in order to keep the system moving upward rather than down the way it did in 1930-33 and again in 2008. They do not dare let the largest banks go under.

When Draghi said the ECB would do whatever it takes to save the eurozone, he had in mind big banks. This is what every central banker has in mind.

Draghi assumed that the politicians will fall in line. They always have before. He does not think times have changed.

But to move in the direction Draghi says is imperative means fiscal union imposed by frightened members of European national parliaments. He does not think for a moment that the voters should be allowed to decide this, for there will be more than one nation whose voters decide against fiscal union. The creation of a 17-member eurozone with power over each nation’s budget will not be imposed by another treaty. It will be imposed by political fiat, a fiat that will be matched by central bank fiat money.

Can it hold? Can the elected legislators who impose this system retain their offices and thereby head off secession? I don’t think so.


Draghi is just another former Goldman Sachs agent. He is whistling past the graveyard.

What is that graveyard? The graveyard designed almost a century ago by the consummate globalist of modern times, Jean Monnet. He is widely acknowledged as the designer of the New Europe.

His Wikipedia entry says:

In 1955, Monnet founded the Action Committee for the United States of Europe in order to revive European construction following the failure of the European Defense Community (EDC). It brought political parties and European trade unions together to become a driving force behind the initiatives which laid the foundation for the European Union as it eventually emerged: first the European Economic Community (EEC) (1958) (known commonly as the “Common Market”), which was established by the Treaty of Rome of 1957; later the European Community (1967) with its corresponding bodies, the European Commission and the European Council of Ministers, British membership in the Community (1973), the European Council (1974), the European Monetary System (1979), and the European Parliament (1979). This process reflected Monnet’s belief in a gradualist approach for constructing European unity.

It adds this: “On 6 December 1963, Monnet was presented with the Presidential Medal of Freedom, with Special Distinction, by President Lyndon Johnson.” This was 13 days after Johnson had become President. If you don’t think this indicates the enormous power of Monnet, you do not understand Presidents’ calendars.

The ECB is an extension of his power, a generation after his death. So is the European Union. So is the eurozone. Will they collapse? No. Will they slowly disintegrate? Yes. Why? Because the dream of political centralization in our day is the dream of central planning in every area of economic life. Central economic planning always produces disintegration.

Keynesians deny this. Keynesian investors put their money where their faith is. They are going to lose most of their money.

August 4, 2012

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 31-volume series, An Economic Commentary on the Bible.

Copyright © 2012 Gary North