Back in August of 2007, Moldbug explained that the business cycle is really a central banking cycle.

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There is no conceivable way for “the system to collapse.” Much as the Fed would like us to think, the Ring has not been cast into Mount Doom. The lender of first and last resort has a printing press and shows no signs of smashing it.

For this reason, leverage is certainly not “a thing of the past.” Some of the hedgies who have been picking up nickels may need to be peeled off the steamroller wheel. Others will take their place.

The acute crisis of the financial system is a complexity breakdown in the regulatory system. The proximate cause is the existence of a large set of securities whose current market price appears to be much lower than their current regulatory-accounting value.

Investors did not buy subprimes and CDOs because they were stupid. They bought these instruments for a variety of quasiregulatory reasons which seemed politically sound at the time, but since have become invalid.

This is what happens when you speculate on political decisions, a task which by now consumes most of the combined brain and computer power of the financial world - certainly more than it spends on analyzing the productive economy.

For example, pension funds were required to buy AAA-rated bonds, and the ratings were obligingly issued by ratings agencies which had in effect become parts of the federal government, meaning they could face no market consequences for a failure of common sense, such as that implied by models which assumed the future would mirror the past. For example, banks could buy credit protection from hedge funds that were sure to vanish in a stiff breeze, without alarming the creditors of those banks, because the Fed would not let J.P. Morgan fail.

And, most of all, the global central banking system, considered as a unit, was dependent on the incredibly pathological practice of printing money to buy bonds. The “savings glut!” Of course, to the bond market, it makes no difference that the cycle of dilution crossed borders. The Fed printed a dollar, then the PBOC printed eight yuan to buy it, then bought an US mortgage security with the dollar. So? As far as it affected financial markets, Prof. Bernanke could simply have been buying American securities with fresh green Benjamins. The whole Voldemort game is smoke and mirrors.

The result of these abuses was to completely obliterate any semblance of a natural price signal in the money market. All interest rates at all maturities in all currencies were the consequence of official decisions. Price signals were only visible in risk spreads. And even there - as many found to their discomfiture - official action, such as the ratings mess, induced many to buy instruments whose risk was assigned administratively, not inferred by markets.

I state all of these propositions in the past tense. But if they were really past, leverage would indeed be a “thing of the past.” They are not and it is not.

The chronic problem is that “the economy” - in other words, the set of statistics that influence political events - is dependent on these abuses. If they were to be genuinely terminated or even scaled back, a massive “recession” would be inevitable. Some kind of “slowdown” is probably inevitable even now.

If central banks were genuinely independent, they would love a “recession,” because a genuinely independent currency issuer always wants to maximize the price of its currency relative to other goods. This can be done easily - stop creating money. I’ll bet the Fed could drive the dollar up to fifty pounds if it really wanted, assuming of course the Brits didn’t fight back.

Obviously this is ridiculous. So the “Greenspan put” or the “Bernanke airforce” have nothing to do with personalities. Central banks do not have the political power to orchestrate sustained “recessions.” At most they can do what they are doing now - creating shocks that destabilize overextended speculators, and may result in “accidental recessions” that are in fact quite predictable.

The problem is that long-term markets are learning to look past these shocks and see the big picture. And the big picture is that avoiding a “recession” in the present monetary configuration requires long-term interest rates at 5%, and (it seems) short-term rates even lower - combined with asset-price appreciation and money-supply growth above 10% per year.

The difference between these numbers is a hemorrhage of money. It is a river of cash flowing from Printing Press to Bond Market. And indirectly, thus, to voters - who have no knowledge of what it means to be cut off from this river, and no intention of finding out.

The long-term financial effect of this distortion is that any durable goodwhose price is reasonably sure to ascend linearly with the amount of money available to buy it will beat a T-bill. Over 10 years, the difference between 5% and 10% is pretty big. Especially if you add a little leverage.

And the effect, of course, is even larger if all the speculators pile into the same asset. Such as mold. Essentially, the market is responding rationally to a leaky monetary system by trying to create a new one.

This is Mises’ “flight to real value.” Since the CBs have shown great discipline in obeying their CPI indicator, which obviously has no direct influence on any financial market, the hyperinflationary spiral Mises’ phrase implies has not occurred and can’t. A hyperinflationary spiral (in which everyone flees to assets whose price will increase proportionally to monetary dilution) cannot avoid a CPI effect, so this brake is effective.

However, the CBs have yet to face a difficult choice: the stagflationary problem of whether to relax CPI targets, or visibly impose austerity. If the CPI targets are relaxed, the hard-asset speculators will become incredibly jazzed, and it will be very difficult to regain the credibility needed to stop the slide. But it is not clear to me that the CBs have much tolerance for austerity to begin with.

But the guys at the Fed are incredibly smart, and no doubt they will solve the problem as they have in the past. This is the art of central banking - creating temporary crises in which the price of your currency increases relative to other assets, to break the speculators who would otherwise drive it to zero in five seconds with the use of infinite leverage. It’s a stupid and pointless game, but it won’t stop any time soon.

Ultimately, the entire practice of printing money to purchase or guarantee financial instruments - public or private, foreign or domestic, short-term or long-term, is an appalling abuse of power. It is a leftover from the century of socialist mercantilism. And if the citizens of the world ever figure out that the authorities who pretend to be curing the business cycle are in fact in the business of causing it, I wouldn’t want to be anywhere near Washington DC.