"Policymakers have chosen to ignore the central issue of debt as they try to resuscitate activity," warns Satyajit Das in a shocking Op-Ed in today's FT, and with global central banks now printing $180 billion a month (and growing), "the global economy may now be trapped in a QE-forever cycle," confirming von Mises prescription that "there is no means of avoiding the final collapse..."
The European Central Bank and Bank of Japan are buying around $180 billion of assets a month, according to Deutsche Bank, a larger global total than at any point since 2009, even when the Federal Reserve's QE programme was in full flow.
And if market consensus proves accurate, that total is about to rise by billions more
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But as Das details, a combination of QE and the prospect of fresh fiscal stimulus won’t generate a recovery.
Since 2008, total public and private debt in major economies has increased by over $60tn to more than $200tn, about 300 per cent of global gross domestic product (“GDP”), an increase of more than 20 percentage points.
Over the past eight years, total debt growth has slowed but remains well above the corresponding rate of economic growth. Higher public borrowing to support demand and the financial system has offset modest debt reductions by businesses and households.
If the average interest rate is 2 per cent, then a 300 per cent debt-to-GDP ratio means that the economy needs to grow at a nominal rate of 6 per cent to cover interest.
Financial markets are now haunted by high debt levels which constrain demand, as heavily indebted borrowers and nations are limited in their ability to increase spending. Debt service payments transfer income to investors with a lower marginal propensity to consume. Low interest rates are required to prevent defaults, lowering income of savers, forcing additional savings to meet future needs and affecting the solvency of pension funds and insurance companies.
Policy normalisation is difficult because higher interest rates would create problems for over-extended borrowers and inflict losses on bond holders. Debt also decreases flexibility and resilience, making economies vulnerable to shocks.
Attempts to increase growth and inflation to manage borrowing levels have had limited success. The recovery has been muted.
Sluggish demand, slowing global trade and capital flows, demographics, lower productivity gains and political uncertainty are all affecting activity. Low commodity, especially energy, prices, overcapacity in many industries, lack of pricing power and currency devaluations have kept inflation low.
In the absence of growth and inflation, the only real alternative is debt forgiveness or default. Savings designed to finance future needs, such as retirement, are lost.
Additional claims on the state to cover the shortfall or reduced future expenditure affect economic activity. Losses to savers trigger a sharp contraction of economic activity. Significant writedowns create crises for banks and pension funds. Governments need to step in to inject capital into banks to maintain the payment and financial system’s integrity.
Unable to grow, inflate, default or restructure their way out of debt, policymakers are trying to reduce borrowings by stealth. Official rates are below the true inflation rate to allow over-indebted borrowers to maintain unsustainably high levels of debt. In Europe and Japan, disinflation requires implementation of negative interest rate policy, entailing an explicit reduction in the nominal face value of debt.
Debt monetisation and artificially suppressed or negative interest rates are a de facto tax on holders of money and sovereign debt. It redistributes wealth over time from savers to borrowers and to the issuer of the currency, feeding social and political discontent as the Great Depression highlights.
The global economy may now be trapped in a QE-forever cycle. A weak economy forces policymakers to implement expansionary fiscal measures and QE.
If the economy responds, then increased economic activity and the side-effects of QE encourage a withdrawal of the stimulus. Higher interest rates slow the economy and trigger financial crises, setting off a new round of the cycle.
If the economy does not respond or external shocks occur, then there is pressure for additional stimuli, as policymakers seek to maintain control. All the while, debt levels continue to increase, making the position ever more intractable as the Japanese experience illustrates.
Economist Ludwig von Mises was pessimistic on the denouement. “There is no means of avoiding the final collapse of a boom brought about by credit expansion,” he wrote. “The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
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