Back in early 2009, just around the time the Fed announced it would unleash QE1, we warned that any attempt to reflate the debt (a pathway which ultimately leads to hyperinflation as monetary paradrops are the only logical outcome as a result of the deflationary failure of the intermediate steps) would fail, and instead would saddle the world with even more debt, making monetary financing, i.e., paradropping money, the inevitable outcome.
We said that instead, the right move would be to liquidate the excess debt, and start anew - a step which, however, would wipe out trillions in (underwater) equity, something which the status quo would never agree to, as that is where the bulk of its wealth is contained.
7 years later, debt is well over $200 trillion, having risen by more than $60 trillion in the interim, and we are rapidly approaching the peak of the world's debt capacity as we noted a month ago in "The World Hits Its Credit Limit, And The Debt Market Is Starting To Realize That."
Today, we find that none other than Adair Turner, a member of the Bank of England's Financial Policy Committee and a Chairman of the Financial Services Authority, wrote a long essay in Bloomberg which admits everything we have warned about.
Advanced economies' public debt on average increased by 34 percent of GDP between 2007 and 2014. More important, national incomes and living standards in many countries are 10 percent or more below where they could have been, and are likely to remain there in perpetuity.
The fundamental problem is that modern financial systems inevitably create debt in excessive quantities. The debt they create doesn't finance new capital investment but the purchase of existing assets, and above all real estate. Debt drives booms and financial busts. And it is a debt overhang from the last boom that explains why recovery from the 2007–2008 crisis has been so anemic.
... debt contracts also have adverse consequences: They're likely to be created in excessive quantities. And the more debt an economy assumes, the less stable that economy will be. The dangers of excessive debt creation are magnified by the existence of banks and the predominance of certain kinds of lending. Almost any economics or finance textbook will describe how banks take money from savers and lend it to borrowers, allocating money among investment options.
At the core of financial instability in modern economies lies this interaction between the infinite capacity of banks to create new credit, money and purchasing power, and the scarce supply of urban land. Self-reinforcing cycles of boom and bust are the inevitable result.
His punchline: "unless tightly constrained by public policy, banks make economies unstable."
If central banks increased interest rates to slow the credit growth, standard economic theory said lower real growth would result. The same pattern and the same policy assumptions can now be seen in many emerging economies, including China: Each year, credit grows faster than GDP so that leverage rises and credit growth drives economies forward.
And then this:
But if that is really true, we face a severe dilemma. We seem to need credit to grow faster than GDP to keep economies growing at a reasonable rate, which leads inevitably to crisis, recession and debt overhang. We seem condemned to instability in an economy incapable of balanced growth with stable leverage.
Hmm, this sounds exactly like what we said in 2010: "Why The Staggering U.S. Debt Load Is Sure To Prevent Economic Growth." But what does a fringe, tin-foil blog know.
So, yes, the very top echelon of central bankers finally admits what we have said all along: creating excess debt creates asset bubbles, slows down growth, recurring crises and leads to even more "unconventional", and taxpayer funded systemic bailouts.
Hardly a surprise.
What does Turner recommend?
For the answer we have to go back to what he said yesterday in an IMF paper titled "The Case for Monetary Finance – An Essentially Political Issue." But before going into it, here is what the WSJ reported the IMF new chief economist, Maurice Obstefld, said:
“I worry about deflation globally,” new IMF Economic Counselor Maurice Obstfeld said in an interview ahead of an annual IMF research conference that focuses this year on unconventional monetary policies and exchange rate regimes. “It may be time to start thinking outside the box.”
Weak—and in some cases falling—price growth has plagued Japan, Europe, the U.S. and other major economies since the financial crisis. Plummeting commodity prices are exacerbating the so-called “lowflation” and deflation problems that curb investment, spending and growth.
Surveying several dozen of the largest economies around the world, Mr. Obstfeld said the number of countries experiencing low inflation is rising. Combined with slowing emerging market output, ballooning government debt and monetary policy constrained by the lower limits of interest rates, the deflation risk is fueling fears the global economy could be fast stuck into a deep low-growth mire.
Yes, this comes as the Fed is desperately pushing for a rate hike, just so it can telegraph that "things are better than they seem." It remains to be seen how successful this experiment will be: we know that every single country that has been at ZIRP or below, and has tried to hike rates, has promptly failed most notably the case of Japan in August 2000 when it, too, hiked by 25 bps from 0% only to lower 7 months later.
Which brings us back to Adair Turner, and his note on "monetary financing." This is what he says:
“Monetary finance” is defined as running a fiscal deficit (or a higher deficit than would otherwise be the case) which is not financed by the issue of interest-bearing debt, but by an increase in the monetary base – i.e. of the irredeemable fiat non-interest-bearing monetary liabilities of the government/central bank.
The easiest way to think about this is in terms of Friedman’s “helicopter money”, [Friedman, M. 1960] with the government printing dollar bills and then using them to make a lump-sum payment to citizens.
But in modern reality:
- It could involve either a tax cut or a public expenditure increase which would not otherwise occur.
- It can be one-off or repeated over time.
- And it would typically involve the creation of additional deposit rather than paper money. This would be initially in the form of deposit money in the government’s own current accounts which would then be transferred into private deposit accounts either as a tax cut or through additional public expenditure.
And the punchline: this is what the upcoming monetary paradrop will look like:
There are a number of ways in which the money could be “created” with different precise implications for the central bank balance sheet. They include:
- The central bank directly credits the government current account (held either at the central bank itself or at a commercial bank) and records as an asset a non-interest-bearing non-redeemable “due from government” receivable
- The government issues interest-bearing debt which the central bank purchases and which is then converted to a non-interest-bearing non-redeemable “due from government” asset
- The government issues interest-bearing debt, which the central bank purchases , holds and perpetually rolls over (buying new government debt whenever the government repays old debt), returning to the government as profit the interest income it receives from the government. In this case the central bank must also credibly commit in advance to this perpetual rollover.
But the choice between these different precise mechanisms has no substantive economic consequences, since in all cases:
- The consolidated balance sheet of the government and central bank together is the same.
- The monetary base of irredeemable non-interest-bearing money is increased
- And the government is thus able to cut taxes or increase expenditure without incurring any future liability to pay more interest, or to redeem the capital value of the money created.
And so on: there is more in the paper which we suggest everybody reads as it lays out precisely what will happen once the next attempt to reflate fails.
What is more disturbing, is that this is now effectively policy: with this paper by one of the most respected economists among the intellectual oligarchy, which expressly endorses "monetary financing" it is just a matter of time before it goes from theory to practice, first in Japan within the next five years. Quote Turner:
Monetary finance in today’s economic circumstances. I argue that monetary finance should be an available policy tool, and that in at least one country – Japan - it not only should be but inevitably will be used within the next five years.
First in Japan, then everywhere else and... on a "continuous basis."
I also consider whether money finance should be used only as an emergency measure in the face of a post-crisis debt overhang, or whether, faced with possible secular stagnation, we will have to use it on a continuous basis.
So the blueprint for what is coming has now been laid out and only those who willingly refuse to see what is before them, will be surprised when "monetary financing" is finally unveiled.
In conclusion we go back to Turner's op-ed in Bloomberg from this morning in which he says:
Many people are legitimately angry that few bankers have been punished. Some were incompetent, others dishonest. Yet they were not a fundamental driver of the crisis any more than the misbehavior of individual financiers in 1920s America caused the Great Depression.
The hypocrisy is astounding: in one paper Turner promotes a policy that will perpetuate, and reward, the banking status quo, and in another letter he urges punishment for the very same bankers who will benefit the most from having robbed the middle class for the past 7 years thanks to policies enacted by people like him!
The sad truth, however, is that after reading the above, one barely even has the energy to feel disgust.
But perhaps just to help spark if not disgust then a little bit of anger, we will conclude with the quote used by Turner at the very top of his paper which confirms that at least one person knew how it was all going to end a long time ago:
“Consider for example a tax cut for households and businesses that is explicitly coupled with incremental Bank of Japan purchases of government debt – so that the tax cut is in effect financed by money creation”
Ben Bernanke, Some Thoughts on Monetary Policy in Japan, 2003
* * *