Central Banks And The 2008 Bubble: Chicken Or The Egg?

What jumps out at you should be the quadrupling of the their balance sheets since 2007 from $3.5 trillion to over $14 trillion.

So what exactly does this mean? Basically, to keep the system from imploding upon itself the world's central banks had to "create" over $10 trillion of liquidity by purchasing assets onto their balance sheets. This is puts forth a "chicken or the egg" question, or actually two as you will soon see.

First, central banks have been buying everything ...including stocks, to prevent the markets from turning down. It is safe to say they understand that with the leverage and derivatives outstanding they cannot allow markets to correct (or God forbid actually enter bear markets). They understand the "size" of the derivatives markets is so large, NO ONE can withstand a downturn and actually be called upon to perform their "insurance payments".

So the central banks have a problem here, they are now "forced" to purchase assets to prevent market downturns but one should ask the question "who will they eventually sell to?" The answer of course is "no one" because there is no one large enough to take these assets off their books. Chicken or the egg question number one; did the central banks create the bubble going in to 2008 or did the bubble of 2008 create the current central bank balance sheet bubble?

While you are pondering that question, let's look at another, much more important chicken or the egg question. Central banks "create money" via credit. They are now buying all sorts of assets from "pristine" (sovereign debt) to "ugly" (junk debt to get it off of bank balance sheets) to truly "stupid" (stocks). Also, please keep in mind central banks for the most part are the issuers of currencies, their balance sheets and what they are comprised of "backs" the currency. They have put themselves in the position of buying assets they know they can never sell. They can never sell because there are no buyers large enough to buy, AND, they would then be creating the downturn in markets they originally denied if they ever stopped buying let alone selling assets.

With the above in mind, what does this mean for the currencies they issue? Won't they be forced to continually purchase ever more assets to prevent markets from collapsing? And doesn't an ever larger balance sheet mean money supplies expanding and thus more currency units outstanding versus basically static amounts of real goods available? Do you see where this is going?

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OK, chicken or the egg question number two; the central banks by definition create inflation (via currency and credit), does the continual creation of their "product" (fiat) in order to prevent the destruction (deflation) of their product ...actually destroy their product? Simplified, because "money" MUST be created at ever greater amounts to avoid deflation, are the central banks forced to ultimately destroy their currency? The answer of course is YES. Central banks are forced in the exact same mathematical manner as any Ponzi scheme ...to issue currency in an exponential manner.

What has actually happened was entirely predicable since 1913. At some point the U.S. (and thus the entire world as the dollar is the reserve currency) would reach debt saturation by definition. We did so in the 2006-2007 era. The only balance sheets left to "reflate"at that point were the sovereign treasuries/central banks themselves. They by result have destroyed their own balance sheets over the last 10 years.

It is only a matter of time until this is fully recognized by the investing/consuming public and thus lose confidence in the central banks themselves. At this point, central banks will destroy their own currency by doing what they do ...creating currency and credit. From here, the faster they run, the faster the boogeyman catches them!

Written By: Bill Holter