It’s over. Trust in the once almighty power of the central banks has almost completely vanished. Sure, there are still some holdouts who believe that central banks could fix all problems in the real economy as well as in financial markets, primarily by just printing more money. As becomes clearer every day, central banks are not going to help us out of the crisis. They are the ones who got us into it and make it worse every time they intervene. That is the „medicine“ they have prescribed for more than 30 years already. It is time to stop them!
To be very clear: Without the central bank policies of the past thirty years, we would not have a global debt crisis, no asset bubble, no discussion on inequality and no deflation. Oil would also not be at $30. Don’t believe it? Let me jog your memory.
The „Greenspan Put“ is firmly in the Wall Street dictionary. Whenever there was some turbulence in financial markets or the economy, the U.S. Fed – and, along with it, all major central banks in the world – came sailing to the rescue. Lower interest rates and more „liquidity“ (read: money) were injected. The result? The crash of 1987, the Russian crisis, the Asian crisis, the LTCM bankruptcy, dot-com-bubble and the global financial crisis. In all cases, speculators and banks knew that the central bankers had their back.
Given the U.S. Fed’s path, the other major central banks of the world really had no choice but to follow. The price of not following Washington’s command would have been to risk a steep appreciation of their own currency and a loss of export competitiveness.
Here is the remarkable development: Contrary to the constant soothsaying by Mr. Greenspan et al., after each of these crises, interest rates never returned to pre-crisis levels. As the Bank for International Settlements has warned for years, this asymmetric reaction on the part of central banks laid the foundations for an ever-bigger crisis, forcing the already low interest rates lower still. The new central banking mantra? Low rates today require even lower rates tomorrow.
No wonder, then, that rates went lower and lower for decades. It became more and more attractive to work with borrowed money. „Leverage“ became the fuel of the markets. „Debt“ became the answer to all problems we might face.
Using leverage for financial gains
More competition from China leads to downward pressure on wages? No problem, just embark on a strategy where everybody gets rich by buying real estate, even with no money down (as the U.S. did so spectacularly). More competition leads to higher unemployment? That’s no problem. After all, we have social welfare (that was the preferred European solution).
The rationale remains the same in either case: The higher the leverage given of a system, the higher the probability of a crisis.
This „logic“ forced central banks to intervene even more, creating even stronger incentives to borrow and to use leverage for financial gains. The medicine provided by the central banks made the addicts more addicted.The result: Never before has the world economy been as highly in debt as it is today. We are reaching the limit of debt capacity. All those able and willing to take on debt are already heavily in debt.
An ever-bigger proportion of new debt is just taken on the pretense to „serve“ already outstanding debt. The practical result of that is that the old justification – generating a demand effect for the economy — is shrinking rapidly. Et voila, we enter the secular stagnation.
Piketty would be an unknown economist
Closely linked to the debt wave is the development of asset prices. One hundred of the 400 richest Americans made their fortune with „investments“, most of them with cheap credit. Similarly, banks, hedge funds and private equity firms achieve their impressive returns only thanks to extreme leverage.
The mechanism is well known: As others ride this bandwagon as well, the demand for the stock goes up, leading to higher prices. This not only makes some people even richer, but they can even borrow more to buy more stocks. The lower the interest rates and the lower the required equity, the higher asset prices can and will rise. The policies of the central banks for the past 30 years were therefore nothing other than a one-way, low-risk street to fortune for those who could play the game.
Without the central banks, Thomas Piketty who wrote the best-selling book „Capital in the 21st Century“, a heavy treatise about inequality, would have had to look for another research topic.
Catering only to a select few
But even though his book runs some 800 pages, he did not make the connection that growing wealth and inequality were closely linked to the debt super-cycle of the past 30 years. He is thus describing symptoms, not causes. Alas, even today it is becoming only very gradually clearer to the general public that the central banks – supposedly geared toward protecting the safety and soundness of the financial system — benefit only those with assets.
Make no mistake about it: The U.S. Fed – and all the central banks that followed it so eagerly — are not working for the good of overall society — just for the good of a small group. It is only logical that Ben Bernanke, one of the biggest proponents of this policy, joined the hedge fund Citadel after stepping down as Fed Chair. High time for him to cash in himself on the cheap money and unlimited „leverage“ strategy.
Crafty as they are, at no instance did central bankers miss an opportunity to justify their actions by the need to defend against deflation, i.e., falling prices. They profess to fear a self-enforcing doom cycle, like the one that the world experienced during the Great Depression.
Alas, that depression was caused – like our crisis today – by too much debt. A modest amount of deflation in itself is not bad. Over decades, the United States and other European countries experienced falling prices and high employment – paired with impressive growth. Deflation is normal in an economy where competition truly works and which features continuous productivity gains.
In reality, central bankers had quite a different form of deflation in mind – deflation in asset markets, as this would cause the debt bubble to burst, leading to a collapse of the whole financial system. This is where the real sting occurs: Any effort to prevent a bursting of asset bubbles intensifies the deflationary pressure in the real economy, as bad investments and overcapacities are not cleared from the market. Normally, such companies and assets would disappear in a recession.
Low interest rates
But that does not happen in today’s world, where zero interest rates and banks, which cannot afford any write-offs in their books, lead to zombie companies still hanging around. They are not investing and they are poisoning the waters for others who could still make investments.The net effect for regular folks is that, as savers, they need to save more for retirement since the return on their savings is zero or negative. More likely, they need to work ever later in life – if they have careers that let them.
Western institutions have long criticized the Chinese authorities for operating in a relentlessly debt-dependent economy. Truth be told, the Chinese are just following our example. The common denominator is cheap money, which encourages investments that are not as attractive as in periods with normal interest rates.
Explaining the crisis
The whole cycle unfolded like this: Once the Chinese started their own debt-financed party, they drove up commodity prices worldwide. This encouraged commodity exporters to invest in bigger capacities. Then, low rates encouraged the shale gas investment boom in the United States.
Now, as global demand drops, the extended capacities drive down the price of oil and other commodities, further destabilizing many regimes that were already on the brink politically, economically and socially. At first glance, this seemed like a promising strategy, considering that lower oil prices tend to boost domestic demand in oil-importing countries.
But at a systems level, the bigger problem is the pressure faced by the oil-exporting countries to sell financial assets in order to make ends meet. This reduces worldwide liquidity and therefore risks to cause falling asset prices – as can be seen in the stock markets since the fall of 2015.
Of course, our central banks will come up with a solution to this upcoming crisis: Yet more money!
Dismantle the central banks
It is fascinating to see that even more than 30 years of mismanagement by central banks, with significant damage to the real economy, has not yet dispelled the „hope“ of politicians, business leaders, financial markets and the broader population of our countries that recovery rests on the shoulders of the central banks.
In the next emergency, we will once again see pictures of Yellen, Draghi and Co. assuring us that they will „rescue“ the world one more time with their interventions. In reality, they are poisoning us even more! The false medicine of the central banks is less and less effective. The side effects are more and more visible. Once the financial markets lose trust in the almighty power of the central banks, we will face the „mother of all crises“.
The fickleness of so many bank stocks these days is a bad omen, indicating that this day may be near. It is time for a fundamental shift in policy – if we can still bring it about. Either way, try we must. We need to stop the nefarious machinations of the central bankers, especially the high priests working at the U.S. Fed.