The great tragedy of the global economic malaise is that it is caused by a shortage of something that is essentially costless to produce: money.
Both banks and governments can produce money at physically trivial costs. Banks create money by creating a loan, and the establishment costs of a loan are miniscule compared to the value of the money created by it—of the order of $3 for every $100 created.
Governments create money by running a deficit—by spending more on the public than they get back from the public in taxes. As inefficient as government might be, that process too costs a tiny amount, compared to the amount of money generated by the deficit itself.
But despite how easy the money creation process is, in the aftermath to the 2008 crisis, both banks and governments are doing a lousy job of producing the money the public needs, for two very different reasons.
Banks aren’t creating money now because they created too much of it in the past. The booms that preceded the crisis were fuelled by a wave of bank-debt-financed speculation on some useful products (the telecommunications infrastructure of the internet, the DotCom firms that survived the DotCom bubble) and much rubbish (the Liar Loans that are the focus of The Big Short). That lending drove private debt levels to an all-time high across the OECD: the average private debt level is now of the order of 150% of GDP, whereas it was around 60% of GDP in the “Golden Age of Capitalism” during the 1950s and 1960s—see Figure 1.
Figure 1: The private debt mountain that has submerged commerce
In the aftermath of the Subprime bubble, credit-money creation has come to a standstill across the OECD. In the period from 1955 till 1975, credit grew at 8.7% per year in the United States; from 1975 till 2008, it grew at 8% per year; since 2008, it has grown at an average of just 1.5% per year. The same pattern is repeated across the OECD—see Figure 2. Globally, China is the only major country with booming credit growth right now, but that will come crashing down (this probably has already started), and for the same reason as in the West: too much credit-based money has been created already in a speculative bubble.
Figure 2: Credit growth is anaemic now, and will remains so as it has in Japan for 25 years
Japan, of course, got mired in this private debt trap long before the rest of the world succumbed. As Figure 1 shows, its private debt bubble peaked in 1995, and since then it’s had either weak or negative credit growth, so that its private debt to GDP level is now in the middle of the global pack. Economic growth there has come to a standstill since: Japan’s economy grew at an average of 5.4% a year in real terms from 1965 till 1990, when its crisis began; since then, it has grown at a mere 0.4% a year.
That gives us a simple way to perform a “what if?”. What if the rest of the OECD is as ineffective at escaping from the private debt trap as Japan has been? Then the best case scenario for global credit growth is that it will match what has happened since Japan “hit the credit wall” in 1990.
We can guess at that by shifting Japan’s credit growth data forward 18 years, since its crisis began in 1990 while the rest of the world landed in the trap in 2008. Figure 3 shows the result of that exercise—here measuring credit growth as a percentage of GDP—and that predicts an average growth of credit from now till 2035 of 0.5% of GDP a year.
It’s worse still when you consider that most of Japan’s post-crisis credit growth occurred in the first half decade or so after its crisis. Take those early post-crisis years out, and the average rate of growth of credit in Japan has been minus 3 percent of GDP a year. Rather than adding to the money supply, banks have been reducing it for the last 20 years.
Figure 3: Predicting future OECD credit growth on the basis of Japan’s record for the last 18 years.
What about governments? Here we run into a problem with ideology—and bad metaphors. Inspired by visions of a no-government, free market idyll, conservative politicians from Reagan and Thatcher on have promoted restraints on government spending, in the hope that slashing government expenditure will allow the more efficient and dynamic private sector to fill the void. So the pressure has been on to reduce the size of the government sector, to avoid running deficits, and preferably to run surpluses, on the argument that the government is “like a household” and should “live within its means”.
This vision would be all very well if we lived in a barter-based economy, but we don’t. In such an economy, exchanges could occur in kind—your pigs for my computers. But in the real world in which we live, trading pigs for computers—or anything else—requires money. And a government deficit, when it is financed by the Central Bank buying Treasury Bonds, is the other way that money is created. The fetish for small government and budget surpluses means that the government has ignored this task, and effectively abrogated money creation to the private banking sector.
This strategy had no obvious negative consequences while the private banks were on a credit-money-creation binge—as they were effectively from the end of WWII till 2008. But once private debt began to dwarf GDP and the growth of credit slowed to a trickle, the inherent stupidity of this policy became apparent. In their attempt to promote the private sector, conservative proponents of small government are actually strangling it.
As someone who spent 2 years warning about this crisis before it happened, and another 8 years diagnosing it (and proposing remedies that would, I believe, be effective, if only banks and governments together would implement them), I find this dual idiocy incredibly frustrating.
Rather than understanding the real cause of the crisis, we’ve seen the symptom—rising public debt—paraded as its cause. Rather than effective remedies, we’ve had inane policies like QE, which purport to solve the crisis by inflating asset prices when inflated asset prices were one of the symptoms of the bubble that caused the crisis. We’ve seen Central Banks pump up private bank reserves in the belief that this will encourage more bank lending when (a) there’s too much bank debt already and (b) banks physically can’t lend out reserves.
How much longer can governments (and banks) continue with failed policies?
On Japan’s record, the answer appears to be “indefinitely”. Japan’s latest inane attempt to reflate its economy was announced just last week: it will now charge negative interest rates on the excess reserves that Japanese banks now hold in their accounts at the Central Bank. The only direct impact of this policy will be to drive up asset prices yet again—and it might even lead to private banks increasing interest rates on loans to the private sector, as has happened in Switzerland. The net effect on the real economy will at best be trivial, and it will do naught to reduce Japan’s private debt burden, which is the nub of its stagnationist problem.
We are hostage to a dysfunctional monetary system, run by people who don’t understand how it works in the first place. No wonder the global economy is in the doldrums, and finance markets are having dyspeptic attacks.