In this week's Off The Cuff podcast, Chris and John Rubino discuss:

• When Does The System Break?
  • When will (hyper)inflation become the greater risk?
• When Will The Central Banks Lose Control?
  • Their intervention is becoming increasingly desperate
• Recession & Debt Exhaustion
  • These are limits that can't be 'printed away' forever
• The Rise Of Authoritarianism
  • More countries are giving the State more power

One of the most frequent questions we're asked here at Peak Prosperity is: When does all this blow up? When do the sins of the past — rampant debt/deificit spending, monetary meddling, cronyism, lies & propaganda, resource despoilage — catch up with us and force a day of reckoning?

Well, in this week's podcast, Chris and John Rubino bravely attempt to answer. Their conclusions aren't pretty; it's better we be forewarned of the risks than slam into them blindly.

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Executive Summary

• The repercussions of the Fed's Free Money Machine
• Why debt-funded state control stagnates productivity
• The importance of the 8-year cycle
• What should guide investors' focus and decisions

If you have not yet read Part 1: How Long Can The Great Global Reflation Continue? available free to all readers, please click here to read it first.

In Part 1, we asked these questions: can we just keep doubling and tripling the economy’s debt load every few years? What if household incomes continue declining? Are these trends sustainable?

In the near-term, we asked: is this Great Reflation running out of steam, or is it poised for yet another leg higher? Which is more likely?

Let’s start by looking at the mechanism that funds the government’s deficit spending, i.e. its ability to borrow and spend enormous sums of money year after year.

The Free Money Machine

The state can afford to continue or increase fiscal stimulus (deficit spending) because the central bank (the Federal Reserve) has created what amounts to a free money machine. Here’s how the machine works.

The federal government issues $1 trillion in new bonds to fund another $1 trillion in deficit spending. The central bank (Federal Reserve) creates $1 trillion with a few keystrokes, and buys the $1 trillion in bonds with newly created money.

The Federal Reserve earns interest on the $1 trillion in bonds it now owns, but it returns this income to the Treasury, minus the Federal Reserve’s relatively modest expenses of operation. Let’s say the bonds carry an interest rate of 2.5%.  The government pays the Federal Reserve $25 billion in annual interest, and the Federal Reserve returns $20 billion annually, so the net cost of borrowing and spending $1 trillion is an insignificant $5 billion.

If this isn’t entirely free money, it’s extremely close to free money.

So in ten years, the Federal Reserve owns $10 trillion more in federal bonds (assuming the bonds are long-term and didn’t mature).

It's no wonder that some economist propose…

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Executive Summary

• Understanding the details of the Ka-POOM! theory
• The end game: hyperinflation
• Transitioning to tangible (vs paper) assets
• The critical importance of timing as things switch from deflation to runaway inflation

If you have not yet read Part 1: When This All Blows Up,  available free to all readers, please click here to read it first.

Ka-POOM!

Now it’s time to revisit the Ka-POOM theory which posits that bubbles will be blown, then they will deflate (or threaten to, more precisely), and that will then be met with more money printing.  Our view is that this cycle will continue until the entire system is utterly ruined, the underlying currencies destroyed.

What the 2008 financial crisis made clear is that when natural market forces work to purge the oversupply of poor-quality debt from the system. The bad mortgages (think subprime), the bad sovereign debts (think Greece), and the loan portfolios of over-extended financial institutions (think Citibank) represented ‘poor quality debt.’  When the market (finally) figured out that those debts would never be repaid at face value, or perhaps at all, turmoil erupted.

During times like these a vicious sequence begins: the market demands higher interest rates for the increased risks it sees. This makes debts harder to service, ultimately triggering defaults, which only compounds the difficulties as interest costs and defaults spiral ever upwards until the system is purged.  Think of it as nature’s way of removing bad credit from the world, the way a lion chases the lamest antelope first.

Because in our fiat currency system ‘all money is loaned into existence’ (see chapters 7 and 8 of The Crash Course on-line video series), during periods of high debt default, the money supply shrinks. Money is created when a loan is made and, conversely, money disappears when a debt defaults (or is paid back). This is the textbook definition of deflation—a common symptom of which is falling prices the cause of which is that there’s just less money (and/or credit) available to chase goods and services.

As a reminder, money is a claim on real wealth and debt is a claim on future money.  All that happens when we borrow more and more is that we push our problems of paying for what we want out into the future.  Which means that…

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