The Sterilization Hoax?

by Nigel Bolton-Shaw on September 5, 2012

ECB Plan Said To Pledge Unlimited, Sterilized Bond-Buying … European Central Bank President Mario Draghi’s bond-buying proposal involves unlimited purchases of government debt that will be sterilized to assuage concerns about printing money, two central bank officials briefed on the plan said. – Bloomberg

Please keep this question in mind as you read what’s below. Over and over, central bankers claim they can “sterilize” the currency that they’ve placed into the economy. But how do they do this?

How do they know how much money to print in the first place? And how do they know how much money to remove from the economy?

When gold and silver circulate, the market itself gives price signals. Too much gold and the price goes down. Too little and the price goes up. Mines open up. More gold is circulated. It’s self-correcting.

But how does a central banker figure out if there’s too much money in the economy? Fiat money doesn’t provide us with any price signals, not immediately observable ones anyway.

The modern central banker is always looking in the rear-view mirror for signals about what to do tomorrow.

Just once we’d like a reporter to step up and ask a banker like Draghi how he and his colleagues will KNOW when to remove money from circulation.

When we see signs of price inflation, he might respond.

To which our intrepid reporter might answer, Isn’t it too late then?

And of course it is by then. In fact, inflation is ALREADY in the system and Draghi is admitting as much when he attempts to assuage fears about monetary depreciation.

If Draghi is addressing fears of monetary inflation, he is granting the argument that inflation is caused by overprinting of money.

This goes to an issue of semantics. These days central bankers use the phrase “inflation” to mean “price inflation.” Inflation actually happens when bankers print a lot of fiat money and it is circulated by money center banks.

So Draghi still isn’t using the term right, but he is addressing the correct argument. The problem is, he doesn’t have an answer for the main question that must be asked in regards to this sterilization plan.

When we read further in the article we do come to an enigmatic explanation of what Draghi intends to do:

To sterilize the bond purchases, the ECB will remove from the system elsewhere the same amount of money it spends, ensuring the program has a neutral impact on the money supply.

At the moment, the ECB mops up the impact of its mothballed bond-purchase program by offering banks weekly term deposits that currently return 0.01 percent.

With the central bank’s deposit rate at zero and the euro-area banking system currently awash in about 800 billion euros ($1 trillion) of excess liquidity, a larger bond program may not present the ECB with a major obstacle.

What we derive from the above is what we already know, however. It is the money center banks have themselves that determines the amount of money in circulation. The article points out that the system is “awash” with euros. What this means is the banks aren’t lending.

What happens when they do lend? Talk of sterilization will go out the window, most likely as it always does. Instead, central bankers will do what they always do. They will hike interest rates.

The idea that monetary policy is a science is doubtful indeed. If it were simply a mathematical facility, Ben Bernanke would not be on QE3 by now. And central bankers would have been able to predict the great credit crunch of 2008.

They didn’t of course. Mervyn King and Ben Bernanke were entirely surprised by it. But these are the same people, along with Draghi who speak so confidently of various kinds of monetary strategies.

We are supposed to believe that Draghi can “sterilize” his bond activities, yet this is the same EU Central Bank that presides over a banking system “awash” with Euros.

What is almost inevitably coming along sooner or later is a large price inflation followed by aggressive monetary tightening.

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