Global central banks have been flooding the world with liquidity in an attempt to fend off debt deflation and re-inflate the global economy…a collective action that is creating the Mother of All Bubbles. On the macro level we are presently experiencing deflationary pressure due to continuing fallout from 2008, and government attempts to reign in deficit spending. But as sure as night follows day, this cycle will run its course, politicians facing re-election will lose their enthusiasm for austerity, and then we will begin to reap the fruit of the relentless central bank money/credit creation. See the February Pimco Investment Outlook by Bill Gross entitled “Credit Supernova. ” Also, David Stockman’s March 30th New York Times op-ed, “Sundown in America.”
Our financial authorities express confidence that they will be able to withdraw the stimulus as the economy strengthens (assuming that it will), and thus generate “controlled” inflation. We should all hope that their confidence is warranted. Destructive as it is, controlled inflation is far preferable to uncontrolled inflation or all-out debt deflation. The lessons of history, however, are not encouraging.
As a reminder of the consequences of unrestrained central bank money creation, I have taped above my computer screen a 100 trillion dollar banknote issued by the Central Bank of Zimbabwe in 2008. This currency was first issued in 1970 as the Rhodesian dollar at approximately par to the U.S. dollar. Inflation in Zimbabwe in 2008 was 89.7 sextillion percent. That’s 89,700,000,000,000,000,000,000%. Zimbabwe is not even the worst case. That distinction goes to Hungary in 1946, with an annual number that I can’t even put a name to, but which peaked at over 200% daily inflation. Weimer Germany is in fifth place at a mere 29,500%. Readers can access a Comprehensive List of Hyperinflations at the Cato Institute.
We’re not likely to see Zimbabwe-like inflation globally, but even at vastly lower levels, global hyperinflation is something unprecedented, and something that is sure to bring a tectonic change in the global order.
Currency wars have been brewing for years, with skirmishes in the form of a steady pace of round robin minor devaluations and interventions. The U.S. set the stage for open warfare with the adoption of QE to infinity last year. Japan took the next step in announcing its own QE to infinity this year. Others will soon follow.
Looking for honest and intelligent commentary on our economic dilemma is a frustrating exercise. The public “debate” around this critical issue consists primarily of propaganda from ideologues who favor continued printing and ideologues who favor cold turkey austerity. Like almost all debate on matters of public policy these days, both camps refuse to acknowledge any value in the opposition, their own contribution to the state of affairs, or the consequences and real suffering that will result from their own prescriptions.
If it sounds like we’re stuck between a rock and a hard place, it’s because we are. If we had taken the hit in 2008, we would be through the worst by now, reset and ready for growth. Instead, we are treated to endless posturing and polarized propaganda, while we continue to impoverish our heirs and the banksters continue to fatten up on taxpayer money.
I recently discovered an author, Charles Hugh Smith, who is generating a comprehensive and important body of work focused on our economic dilemma. I would like to encourage my readers to visit his website, Of Two Minds. In particular I can recommend his book, “An Unconventional Guide to Investing in Troubled Times” for a comprehensive review of the forces generating our economic problems, and an array of insightful ideas for a better way forward.
Below is a recent blog post by Mr. Smith entitled “The Global Economic Disease in 8 Points and the Cure in 4 Points,” reprinted with permission in its entirety (bolds are the author’s).
The Global Economic Disease in 8 Points and the Cure in 4 Points (January 24, 2013) by Charles Hugh Smith.
A mere dozen points describe both the global financial illness and the cure.
The global economy is ill, and everyone who is not mired in denial or a paid shill knows it. Saying it’s healthy doesn’t make it so.
Is it possible to usefully generalize the illness and outline a cure in a few points? Maybe not, but let’s try anyway.
1. Creating and selling credit and leverage became far more profitable than generating goods and services. Financialization—expanding highly profitable credit by leveraging assets and income to the hilt—began in earnest in the early 1980s.
Creating credit is equally easy in fractional reserve systems like the U.S. and command economies like China. Creating leveraged instruments is as easy as writing and selling derivatives, which not coincidentally have risen (in notional value) 700% since the mid-1990s.
We can understand financialization with just two charts: Here is real GDP, up 50%:
Here is total credit market debt owed, up 200%:
Though solid data is hard to come by, financialization is not just more profitable in nominally capitalist America—it is also true in nominally communist China. Real estate speculation is simply the expansion of credit via building phantom assets.
2. The financial sector captured the regulatory and political mechanisms of the Central State. This capture is both direct (buying political relief from regulation, etc.) and indirect: once the market becomes dependent on financial profits, then any threat to those profits threatens the market and thus the wider economy.
Politicians, capitalist, socialist and communist alike, all cave in as soon as economic growth is at risk.
The capture was also ideological. In the West, neoliberal policies (loosening regulatory controls, reducing the size of the State, enabling free flow of capital, etc.) produced huge gains in growth in the initial low-hanging-fruit stage. This gave the ideology real-world credence.
In China, the “to get rich is glorious” slogan embodied an entire ideology of a State-managed market economy that was as dependent on financialization as the West. (In China, financialization is hidden in land deals and loans made by local government and private wealth-management credit/leverage that is off the books.)
3. Financialization incentivized speculative credit bubbles. Speculation reaps huge rewards as the bubble expands, and the economy becomes increasingly dependent on ever-expanding debt for its growth, income, profits and taxes.
When the bubbles burst, they devastate not just the financial sector but the entire economy, which has become heavily dependent on speculative bubbles and continuous expansion of debt and leverage for its growth.
4. The only “cure” that doesn’t cause political pain is to lower interest rates and flood the economy with liquidity, i.e. cheap money, to reinflate a new credit bubble in another asset class. If there are no other asset classes available, then the Central State and Bank will try to reflate the existing bubble (for example, real estate in China).
5. Speculative credit bubbles (neoliberal or command-economy) led to systemic mal-investment and mis-allocation of capital. Suddenly selling autos for a loss to reap the financing fees made sense, as did building McMansions in the middle of nowhere and building more steel mills in China, even though the sector is already plagued with monumental over-capacity.
6. The Central State and Bank responded to the popped speculative credit bubbles by recapitalizing insolvent banks with taxpayer money (or claims on future taxpayers, i.e. bonds) and legitimizing phantom collateral/assets. It is absolutely critical to understand that the political Status Quo will “buy” growth at any price, and as a result the State is blind to the consequences of massive mis-allocation of scarce real capital in mal-investment.
In other words, the State and Central Bank will continue to do more of what has failed spectacularly until they can no longer do so.
The ultimate counterfeited collateral/asset is a sovereign bond. Here is the basis of the claimed legitimacy: “We can always pay the interest on this bond because we have the unlimited power to tax our citizenry, and we will always return your capital because we have the unlimited power to create money.”
Yet if we follow the consequences of these two unlimited powers, we find nations taxed into poverty and currency debauched to a shadow of its former value. How exactly does ruining the economy and currency create legitimate collateral?
The State also legitimizes phantom capital by manipulating stocks and bonds higher and allowing real estate to be marked-to-fantasy or kept off the market. Only a transparent, open market can discover the price of an asset and thus its value as collateral for debt, and destroying or limiting the market’s ability to price assets undermines the legitimacy of all assets and collateral.
7. The Central State and Bank attempted to repair the speculative credit bubble machine by diverting income from the productive “real” private economy to the parasitic financial sector and politically powerful but grossly inefficient cartels and State fiefdoms.
8. The demographics of an aging population and shrinking workforce cannot support the promised entitlements and other State spending. This has been covered in depth in many places, including this blog—for just one example of dozens: Demographics and the End of the Savior State (May 17, 2010).
That’s the core of the disease in 8 points. Here is the 4-point cure:
1. Re-take the regulatory and political machinery of the State from the control of the financial sector. As long as the State and Central Bank’s actions are primarily aimed at sustaining debt bubbles and spreading the losses generated by the financial sector to the rest of the economy, the State and the economy are doomed to implosion: Is the Central State Too Big to Fail or Too Big to Survive? (January 22, 2013)
2. Mark every marketable asset held by every financial institution and corporation to market at the close of each day, including mortgage-backed securities and real estate. This will reveal the “too big to fail” banks around the world as insolvent.
3. Liquidate the insolvent banks in an orderly fashion by auctioning off all of their assets on the open market. This will eliminate the shadow inventory of housing and expose phantom collateral.
4. Relieve the State of all obligations other than being an impartial enforcer of transparent markets, open competition and common-sense regulation to protect the common good and public commons. As I explained in The Grand Tradeoff of Risk/Innovation/Growth and Financial Security (January 21, 2013), the security of State guarantees and promises is illusory: the State can only sustainably spend the surplus generated by the private sector.
As the private sector crumbles under the dead weight of a parasitic financial Aristocracy, the debt-serfdom of financialization and corrupt, inefficient State fiefdoms, the economy can no longer support expanding State obligations and debt.
The citizenry will have to accept that promises issued on the basis of delusional, unrealistic projections of endless growth and debt expansion must be renounced, just as debt based on phantom collateral must be renounced.
Were these four points implemented, the re-set would be difficult but brief, as truth, trust and resilience would be restored to the political and financial systems. Once political and financial resilience has been restored, fixing all the other problems we face enters the realm of the possible. Without these 4 fixes, the system remains brittle, fragile and doomed to implosion.
Collapse of Complex Systems II: Marginal Returns Trigger Implosion
(February 24, 2009)
When Escape from a Previously Successful Model Is Impossible
(November 29, 2012)
Why Expansionist Central States Inevitably Implode
(January 15, 2013)