He'll be among the first to tell you that financial collapse could happen this week or in a decade. It's impossible to tell. In many ways, it's like an avalanche: it's impossible to blame the avalanche on any particular snowflake, but any one of the continuing snowflakes could cause it. What's it look like? The only "bank" with any solvency left is the International Monetary Fund. The IMF has Special Drawing Rights, SDRs, that would allow it to prop up the world when the collapse happens. His most likely scenario would be that all banks around the world, all banks, would be shuttered. After some time, perhaps a few days, perhaps a week, everyone would be able to withdraw 250 or $300 a day for food and energy expenses.I mentioned his book, "The Death of Money", and have been reading it when I get a few minutes here and there. I have to say I'm learning interesting things in every chapter. Enough to get to the rare point of recommending it before I'm done reading it.
- Trying to achieve inflation. This is the root of virtually all of it. The prospect of an extended deflation was so terrifying to the FED that they reduced interest rates to almost zero (ZIRP) - negative real interest rates. But the "natural" tendency for prices over the long term should be deflationary. Why? Productivity increases in manufacturing and continual seeking of lower labor prices should be lowering the prices on goods we buy. The world is deflationary, yet the Fed is pushing inflation.
- ZIRP in turn destroys savers. Anyone saving for college, retirement: anything, earns too little on their savings to really build them. Rickards figures ZIRP has cost American savers $400 Billion each year: "a normalized interest-rate environment of 2 percent would pay $400 billion to savers who leave money in the bank. Instead, those savers get nothing, and the benefit goes to banks that can relend the free money on a leveraged basis and make significant profits."
- ZIRP is what has dried up the loans for small businesses. Small business loans come from bank to bank lending: big businesses either borrow from big banks or get cash easily selling stock. But that interbank lending is unattractive to the banks because they get more profit from doing other things with their money. Since small business is really the job creation engine in the economy, ZIRP is a major factor behind keeping the number of jobs down.
- The whole idea of creating inflation to raise housing prices and stock prices is the so-called "wealth effect". The idea is that consumers see the stock indices on the news everyday and know their 401k savings (such that they have) are tied to the market. In addition they tend to know their house's price, so when those two prices are up, they feel wealthier and spend more. The problem with this is that actual research has failed to turn up much evidence to support the idea. Studies are all over the place so you could honestly say they not only don't know how large the Wealth Effect is, they don't even know if it encourages or discourages spending! At the very least, they can't even calculate if the benefit is worth the cost of the market distortions they're creating.
- Another idea behind inflation, which combines with ZIRP to create negative interest, is that people who realize their savings are evaporating will spend more. The reality is more complex. There's evidence some savers, faced with seeing their savings not growing, double down on the saving, denying themselves even more and trying ever harder to save. As Jim Rickards put it: "As a result, many citizens are saving even more from retirement checks and paychecks to make up for the lack of a market interest rate. So a Fed manipulation designed to discourage savings actually increases savings, on a precautionary basis, to make up for lost interest. This is a behavioral response not taught in textbooks or included in models used by the Fed."
- ZIRP has made the derivatives bubble larger as banking and investment houses try to get higher yields. The total notional value ("face" value) of the world derivatives market is over a quadrillion (thousand trillion) dollars (that was in 2011!) Some financial writers say the actual value is much less than that, "only" 20 to 30 Trillion. It helps to remember Federal Spending is around $3 to $4 Trillion and the entire World GDP is only around $65 Trillion. Quoting Rickards again: "A definitive study conducted by the IMF covering the period 1997– 2011 showed that Federal Reserve low-interest-rate policy is consistently associated with greater risk taking by banks. The IMF study also demonstrated that the longer rates are held low, the greater the amount of risk taking by the banks." It's commonly stated that at least one form of derivative, the CDO (Collateralised Debt Obligation) was behind the 2008 crash. A decade of low interest rate policies have only made this worse than 2008.
This is just a few paragraphs from a single chapter in James Rickards' book. It starts with a fascinating look at economic terrorism that's full of things I've never seen before. If you find this stuff interesting, I recommend it.