Checkmate!

The game of “Let’s keep this Credit Expansion going for as long as possible” may finally be up.

In the Financial Times we read a rather interesting analysis from Tim Lee, founder of financial economic consultancy Pi Economics

Central banks are likely to attempt to ratify current inflated asset values by inflating prices and incomes to avoid a deflationary economic collapse. Unfortunately, sharp reductions in interest rates in the US, UK, and the euro area will lead to a rapid unwinding of the global carry trade, perversely threatening to worsen problems in the credit markets.

The solution would have to involve massive unsterilized intervention by the Japanese authorities, which would have the effect of inflating Japanese prices to a level consistent with the current yen exchange rate, thereby alleviating huge upward pressure on the yen as the carry trade unwinds.

Combined with a similar inflation in the US, this “solution” would require roughly a doubling of the Japanese price level, destroying the real value of Japanese savings.

If the losses are to manifest purely in real terms — via inflation — then they must occur mostly where the savings have been, which is certainly not in the US.

If the Japanese authorities balk at the prospect of such a huge inflation, then global deflationary collapse will be inevitable once the credit bubble bursts.

Checkmate indeed!

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