I was thinking of starting this blog
with a cynical comment along the lines of, last week equity markets came off, I
think we need another €1 trillion from the ECB! – Okay, maybe it wasn’t the
greatest joke but you get the idea. But then the Wall Street Journal beat me to
it, and they weren’t even trying to be funny. In an article on
weaker data in the Euro Zone one could find this remark:
“The unexpected drop in the purchasing
managers’ index survey suggests more stimulus from the European Central Bank
through interest-rate cuts or additional bank lending may be required to
protect the economy from a more severe downturn.”
Sure. And why not?
Over the past 12 months the ECB expanded its balance sheet by 54 percent. At around 30 percent of GDP that balance sheet is now the biggest among the major central banks. The ECB’s printing press is providing an ‘unlimited’ backstop for all those financial ‘assets’ that nobody in their right mind would buy with their own savings, and providing ‘unlimited’ funding for the European banks, which are now permanently in intensive care. And we have to admit the strategy is not without success: Your neighbourhood Greek bank is again a going concern and those Spanish governments bonds are once more highly sought-after investments, even at single-digit yields. So, why not print another €1 trillion to get the economy really going? Isn’t it time the ECB really put its back into this whole stimulus business?
What a great policy ‘stimulus’ was back
in 2001 when the Fed also ‘protected the economy from a more severe downturn’
and kept rates at 1 percent and blew the biggest housing bubble ever and thus
set the world up for an even bigger ‘downturn’ in 2007. If you think about it,
all our present problems are the result of past ‘stimulus’ – of past efforts to
keep interest rates low and to ‘stimulate’ borrowing and encourage leverage.
Now the interventionists of every couleur tell us that we can only get out of
this mess by depressing interest rates even further for even longer.
Einstein said that the definition of
stupidity was to do the same thing over and over again and expect a different
outcome. This makes me wonder if economic intelligence has already been a
victim of this unfolding crisis.
Exit the exit strategy.
That may well be so. Last week I read
somewhere that a hard-left candidate in France (not Hollande, someone even more
to the left of him) demands that the ECB lends money directly to companies. I
think that this idea is not that farfetched considering how quickly and easily
today’s consensus has embraced extreme policy intervention. Only five years ago
it would have been unthinkable that the world’s major central banks would
become the biggest marginal buyers and single largest holders of their
countries’ sovereign debt, or that they would offer unlimited free loans to
their banks with multiple-year maturities against the dodgiest of collateral.
These used to be the type of irresponsible things that responsible central
bankers scoffed at. Today, this is standard practice in most of the highly
industrialized world. What was crazy five years ago is now merely
‘unconventional’.
And this evolution should not come as a
surprise. As I explained in Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary
Breakdown, what we are seeing is indeed the logic
of the state fiat money system taken to its natural conclusion. The raison d’etre of the system was to not leave the
setting of interest rates and the availability of credit to the free market. On
a free market the level of interest rates and the availability of credit are
naturally determined by the available pool of voluntary savings. The idea was
always to massage interest rates to lower levels and to encourage additional
money and credit creation. In a paper money system like ours, the banks’
ability to create deposit money and loans is largely the result of
administrative decisions by the central bank – at least until the banks have
OD’ed on cheap money and the central bank has to use its own balance sheet to
keep credit growth going. This is where we are now.
As is true of all types of market intervention,
once you fix one variable you have to fix others, and sooner or later you have
to get involved in everything. As ever more sections of the economy become
addicted to cheap money, the risk of higher yields and wider risk premiums
becomes an ever more potent threat to the overbuilt house-of-cards. To avoid
collapse, the central bank has to manipulate ever more asset prices directly.
The communist chap from France has
simply anticipated the next step in the degradation of our paper money economy,
the point where not only the government and the banks will be supported
directly by the central bank but also the corporations and the consumer. What
is good for the former certainly must be good for the latter. Why do Greek
restaurants still face the risk of bankruptcy when Greek banks get limitless
cash?
In any case, this development is much
more probable than any kind of ‘exit strategy’ for the central banks. — You
don’t hear about those exit strategies any more, do you? There is a reason for
it. There are none. Every day that the present free-money-madness continues,
the central banks are digging themselves a deeper hole. With ever more assets
mispriced on cheap cash and with ever more balance sheets propped up by free
loans, policy tightening is equivalent to pulling the rug from under the whole
system. There is no way out.
On steroids.
But back to the title of this Schlichter
file. What recovery am I talking about? In Europe there apparently is none. But
data has been improving lately in the United States, if at a snail’s pace. The
‘interventionists’ assign a lot of importance to these developments. Being
interventionists, they pay little attention to the reasons for why we were in a
recession in the first place. There is never much focus on the root causes of
the crisis or any debate about if those have been removed. Recessions just seem
to happen, so do asset bubbles and excessive leverage. All that matters is that
the government creates some growth, then, with a bit of luck, this growth may
just lead to more growth, and sooner or later we may just grow ourselves out of
this mess. Simples.
I think the chances of that happening
are pretty close to zero. And I do not care much about what present data is
supposed to tell us. It does not make much of a difference.
Take the drop in official US
unemployment. Could it be attributed to a decline in labour market
participation as many long-term unemployed – their numbers have been growing
markedly in this recession – drop out of the official labour market altogether?
Or, could it be the result of the mild weather recently? Or, as the optimists
will say, is it the result of additional hiring? Frankly, I don’t know and I
don’t think it matters much.
We know what the problems have been and
still are: misallocated capital and misdirected economic activity on a gigantic
scale as a result decades of artificially cheap money. The policies of the
interventionists – first and foremost zero interest rates and quantitative
easing – were aimed at sustaining these imbalances, sabotaging their
liquidation, discouraging deleveraging and postponing the – admittedly painful
– cleansing of the economy of the accumulated dislocations. This policy has to
a large degree succeeded, maybe with the exception of parts of the US housing
market, which has indeed been correcting from bubble-levels. Other than that, I
believe policy has so far managed to sustain the unsustainable a bit longer and
thus project a false image of stability. Congratulations.
Of course, we can never exclude that
this policy may also generate some additional activity here and there.
Super-cheap money may not only stop the much needed deleveraging and cleansing
but it may even encourage additional borrowing and additional investment. Who
is to say that the trillions of new currency units will not cause some more
balance sheets to get extended a bit further?
Fact is that none of what we see right
now can be taken at face value. Not the equity rally, not yield levels, not
headline economic data. Everything has to be taken with a sizable pinch of salt
given the distortions from an outright surreal monetary policy stance.
But we can be sure about one thing: None
of this should be taken as an indication of improving health. The patient is
still sick but made to run laps around the track with the help of steroids,
amphetamines and massive amounts of caffeine. The economy will not get
fundamentally better until the underlying imbalances have been addressed and
that is only possible if money printing stops and the market is again allowed
to set interest rates and other prices.
I am not sure if the mainstream
economists do really take a lot of encouragement from the manufactured asset
price rally and the occasional green shoots in an economy that remains
freakishly unbalanced and fundamentally sick. I don’t know what the economic
data will tell us over coming months or quarters. I am confident that we are
far from closing the book on the present depression.
In the meantime, the debasement of paper
money continues.
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