The End Of The Central Bank Put: From Mugabenomics To MadMaxnomics
Authored by Joel Guglietta, originally posted at Steen Jacobsen's blog at TradingFloor.com,
There exists a super-Bernanke who proved also a super-Hollande, a gentleman who Japanese Prime Minister Shinzo Abe cannot compete with: his name is Robert Mugabe, the president of Zimbabwe. When he took power, he seized the farmlands of one social group to give them to another social group. Afterwards, in part because the new social group did not manage the farms that well, the economy took a turn for the worse. Therefore, the state issued some bonds to finance its spending and asked the central bank to issue some money to buy this government debt. But they printed big time and turned the printing press into something of a cosmic proportion. According to Professor Steve Hanke from John Hopkins, monthly inflation was 80 billion percent, so per year it is a 65 followed by 107 zeros. This is what I call Mugabenomics, the conjunction of (i) state-forced wealth transfer between two social groups along with (ii) the monetisation of the debt. As we shall see below, Mugabenomics, or at least its mild version implemented now in the Western hemisphere, has drastic consequences on the final episode of the global financial crisis.
Let’s start with the obvious: the Western world is completely bankrupt
The average total debt of the 18 OECD countries is now well above the 330 percent of GDP computed by the Bank for International Settlements (BIS) in 2011 (Figure 1). Government debt ranges from 80 percent to 100 percent of GDP, non-financial corporate debt is higher than 90 percent of GDP and private household debt is higher than 85 percent of GDP. What is less known is that real household debt tripled between 1995 and 2010 (Figure 1; right-hand graphic). “We” (more on this “we” below) are collectively completely broke. What to expect then? History gives an answer.
Figure 1: Non-Financial Debt
Source: BIS Paper, “The Real Effect of Debt”, Stephen G Cechetti, MS Mohanty and Fabrizio Zampolli
During the Middle Ages, lenders used to apply an interest rate to the loans they granted to their kings to make up for the risk they incurred. Back then, what we now call risk premium was death. Indeed, when the kings could not pay back their debt, they sometimes simply slaughtered their creditors. In today’s civilised world, we kill the creditors with two weapons of choice: inflation and “debt restructuration”. For instance, a haircut (debt cancellation is a 100 percent haircut and happened many times during the Bronze Age in Mesopotamia). In the face of the magnitude of the above numbers, the fact that GPP can grow at 2 percent to 3 percent in the US and zero percent to 1 percent in Euroland is totally irrelevant. Monetisation of the debt, ongoing erosion of the value of currencies and a looming 10 percent to 30 percent haircut are inevitable. This is bad news for undercapitalised European banks.
Therefore, even half-smart creditors know for sure that they are going to be obliterated one way or the other. So let’s spend some time on the haircut solution. A very good old paper from the Boston Consulting Group (“Back to Mesopotamia”, Sept. 2011) suggested that politicians would tax wealth to finance controlled debt restructuring and implement an additional tax on real estate. The BCG scenario has not happened yet, but tax has been increasing everywhere for sure. Please do not raise the Cyprus “guinea pig”: the island is the black hole of the black economy where illicit activity makes almost 30 percent of total GDP! Do not say the ECB and IMF opened Pandora's box. They just asked Cypriots to pay what should have been paid in the first instance. It is an insult to common decency to ask European taxpayers to pay the bill for the national sport in Cyprus: the non-payment of VAT, social contributions and income tax, and recycling of criminal money that has lifted the real estate, hospitality and tourism industries.
Still, taxes are rising everywhere. For example, France has a wealth tax called ISF. Moreover, in this country, known as the big sick man of Europe after the fiscal law amendments implemented by former president Nicolas Sarkozy, total taxes due for property capital gain are 54 percent (33.33 percent + 15.5 percent CSG/CRDS + 6 percent others). On top of that, French pay a tax called the ISF on the total value of their property.
However, why has the BCG’s prediction of a much more aggressive wealth tax not materialised yet? Actually, something way smarter than a simple tax on wealth seems to be at work. Before explaining what could it be, let’s go back to the second key point of our story: who is “we” and how did we get there?
When I say that “we” are all broke collectively, this is not exactly true. We need a little bit of granularity. Let’s take the case of the US. The left-hand graphic in figure 2 shows three developments of paramount importance.
- The share of wages in the GDP has been constantly falling since the 1950s;
- The share of profit in the GDP has been steadily rising since the 1980s;
- There is clear evidence of shorter-term profit-wage cycles: when the wage share rises (falls), the profit share falls (rises), shedding light on an ongoing fight between two social groups to capture the highest share of the value added.
What this chart does not show, but what is evident regarding what has been discussed above, is that this steady fall in wages as a share of GDP has been accompanied by a steady rise in private debt.
Figure 2: The Galapagos and the others
Source: FED Saint Louis
How the ecosystem has auto-organised is mind blowing. Wage earners have structurally received a lower share of the value-added and at the same time, because the ecosystem needs to grow constantly to survive. They have sold their future work to the banks to fulfill their social utility: consuming. And all this has happened without any other violence save a salary contract and the compulsory need to fulfill the much-advertised dream of consuming what the other Joneses consume (whatever it is: a house or a USD 200 pair of shoes).
In the same time, the inequality in earnings is back to what it was at the beginning of the 20th century: the top 1 percent gets 25 percent of all incomes. For those living in emerging markets like Russia, China, Mexico, Indonesia, or Brazil, such a polar social structure is the norm. So, I have news for you: the emerging and Western economies have finally converged, but not precisely how we thought they would. On the one hand, we find the top 1 percent living in the Galapagos, a very unique and exclusive ecosystem protected from the harsh conditions of the world. In this ecosystem, they are all kings - they are the Kings of the Galapagos. On the other hand, you have the 99 percent for whom weather conditions are not that stable. They live in the Land of the Others.
Some of the Kings of the Galapagos are creditors (what a difference compared with the Middle Age!) and some are not. But all share a common feature: they have equity shares. That is to say, a property right on the means of production. As we shall soon see, this property right is what really matters; way much more than its price that depends upon the social conventions on what value is and that change time to time.
So where do we go from here? Stifle your yawn, the story ends soon
I have previously described Mugabenomics as a “stylised fact” of what’s going on in the G10. For sure, this is not exactly applicable as G10 countries have institutions that protect both the Kings of the Galapagos and those living in the Land of the Others. More precisely, what they protect are the property rights. And now, all the pieces are in place.
As Donald Trump said, what the FED (ECB, BoJ…) is doing “is good for people like us”. Let’s assume that “us” are the Kings of the Galapagos. It is not that good for those living in the Land of the Others because the “monetary helicopter” never existed. It is the most stupid thing never invented in economics (among many others, agreed): there is no helicopter, there is a queue, and some are at the beginning of the queue and others at the end.
So, back to our Kings of the Galapagos. They perfectly know that if they hold some debt, they will lose a lot, as the BCG hinted. They also know that maybe they will have to endure some wealth tax as French citizens happily pay every year with no other social disorder than the recurrent demonstrations that define our art de vivre. But here, the beauty of the extreme monetisation we are going through now is twofold.
On the one hand, assuming that inflation does not shoot up in Zimbabwean cosmic proportions, current inflation in asset prices – lifted thanks to central bank monetisation - will pay for the risk of a wealthm tax tomorrow. Moreover, should we go back to Mesopotamian times with a write-off of debt and a big celebration, banks would have rebuilt some of their balance sheets in the meantime, too.
On the other hand, if indeed inflation explodes and if the value of money vanished with the complete obliteration of the creditors, the Kings of the Galapagos will end up with the one and only thing that has a real value: an equity share, such as a property right on the means of production. Let me quote what Harold Demsetz writes in Toward a Theory of Property Rights: “[…] an owner of property rights possesses the consent of fellowmen to allow him to act in particular ways. […] Property rights convey the right to benefit or harm oneself or others. [They] specify how persons may be benefited and harmed and, therefore, who must pay whom to modify actions taken by persons." This goes without saying that this holds true in the first scenario too: property power is social power, and social power is all what matters.
This is why the Kings of the Galapagos are long equity under (mild) Mugabenomics. This goes way beyond the so-called put of the central banks, which are there to support asset prices. Yesterday, the multibillion hedge fund Brevan Howard said on Reuters: "Having faith in policymakers' ability to provide a perpetual put may yet prove to be a serious error.
"Tail risks, which have haunted the markets for the last five years, appear to have receded for the time being, but have by no means disappeared."
Yes indeed, I agree with Brevan Howard: the risks have not disappeared. But if so, why assume an end of the central banks’ put?
Well, the central banks could turn their backs on Keynes, become Austrian and raise interest rates in a world of sub-par growth and massive debt. Really? Would they? Having a constant faith in the put of the central banks proved a mistake when the system was within boundaries. But as figure 3 suggests, boundaries have been broken and policymakers are in uncharted territories, or rather territories rarely revisited since Mesopotamian times.
Figure 3: How a complex system evolves during a crisis
Source: Journal of Futures Studies, Feb. 2007, 11(3),:29-46. BestFutures©, Duncan & Graeme Taylor
Indeed, with 46 million US citizens on food stamps and the unemployment rate in some European countries equal to what was seen during the Great Depression, boundaries have clearly been broken. This is not a put, this is a blatant admission that we are at the end of the road,. For example, a major bifurcation. Calling an end to the put of the central banks is moving from (mild) Mugabenomics to MadMaxnomics. This is what figure 3 shows: we are smack in the middle of this bifurcation, If (mild) Mugabenomics goes along with structural reforms, we can hope to move to a world of greater complexity and evolve. If not, there is still the fragmented scenario, which, unfortunately, has not a zero-probability.