ECB President Mario Draghi has cut interest rates again.
Yes, they were already negative. Now they’re even more negative. Because in the world of Central Banking if something doesn’t work at first the best thing to do is do more of it. Whatever you do, DO NOT question your thinking or your economic models at all.
We’ve seen this same scheme play out in the US with QE. By the Fed’s own admission, its QE programs have only lowered unemployment by 0.13% (mind you, the Fed found this by using the overinflated unemployment data from the BLS, the reality is likely even worse).
Then there’s Japan, which has been launching QE for well over 20 years and has never experienced a sustainable uptick in GDP growth or employment. Their thinking was that if spending over 20% of your GDP on QE fails to generated growth, why not announce ANOTHER QE program equal to another 20% of GDP!
At the end of the day, the world is simply too saturated with debt. The reason for this is that Central Banks have promoted easy credit and low interest rates for decades, resulting in everyone and their mother borrowing money to spend, build factories, invest in technology, etc.
This has a diminishing marginal utility. In the 1960s every new $1 in debt bought nearly $1 in GDP growth. In the 70s it began to fall as the debt climbed. By the time we hit the ‘80s and ‘90s, each new $1 in debt bought only $0.30-$0.50 in GDP growth. And today, each new $1 in debt buys only $0.10 in GDP growth at best.
Globally today, debt is now a massive overhang and a drag on growth. When you’re in debt up to your eyeballs, borrowing more money at cheaper rates doesn’t do much for you.
Consider European banks. Taken as a whole, they are leveraged at 26 to 1. In simple terms, this means they have just €1 in capital for every €26 in assets. Remember, for a bank, a loan is considered an “asset.” So this means that the bank generally speaking has made €26 in loans for every €1 in capital on its balance sheet.
When you are leveraged at these levels you only need your assets to fall 4% before you’ve wiped out all of your underlying capital (€26 * 0.04 = €1.04). At that point you are total insolvent.
There is nothing you can do to remedy this situation other than:
1)raise capital
2)pay off your debts
3)default
Borrowing more money at cheaper rates might provide short-term liquidity, but it does nothing to reduce your leverage in the real world. This is why Mario Draghi’s efforts to lower interest rates even further into negative territory will fail. It’s why generally speaking, all Central bank policy is failing to generate growth: Central Banks can’t really do anything to remedy the situation!
However, until the world finally realizes this, we’ll continue to see Central banks engage in absurd schemes to try and generate growth. They will ultimately fail. The question is when.
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Best Regards
Phoenix Capital Research