Negative Interest Rates, Money Heroin and Helicopters

One [Fed] official called for a negative interest rate in 2015 and 2016, something that has been tried in several European countries to boost growth and inflation. The Fed doesn’t identify which officials make specific projections.’

Wall Street Journal 18 September 2015

Even in an optimum scenario Chinas economic growth rate would fall to around zero. We take a quantitative look at the potential magnitude of the collapse of Chinas economic bubble to ensure that we can get a good grasp of the future risk scenario. If a surplus capital stock adjustment were to actually occur, what is the risk for China and how far would its economy fall?

Daiwa Institute of Research

(Japan’s second largest brokerage firm)

Seven long years of stimulus was not supposed to generate talk of negative interest rates in the US and a zero economic growth rate in China.

The Fed’s game plan was for the perpetual debt machine, by now, to be pumping out inflation, high growth rates, jobs galore and normal (whatever normal is these days) interest rates.

Instead we have esteemed institutions such as the IMF, the Fed, RBA, BoJ, ECB et al continually revising downwards their previously optimistic growth forecasts. Why they don’t work on the principle of ‘under-promise and over-deliver’ bemuses me. I think they’re hard wired from decades of debt-fuelled economic propulsion to expect growth, growth and more growth.

They must think the economy is a two-headed coin — with expansion imprinted on both sides.

In a world that is literally geared for growth, the prospect of contraction cannot be entertained.

The reason the unnamed Fed official is looking to put a minus sign in front of US interest rates is because ‘… they projected the economy will grow at a rate between 1.8% and 2.2% in the long-run, down from their June estimate of growth of 2.0% to 2.3% in the long-run. A more lumbering economy has less capacity to bear much higher rates.

When questioned on whether rates would go negative ‘Dammit’ Janet Yellen neither confirmed nor denied the prospect of depositors being charged to park their money (with my emphasis):

Let me be clear that negative interest rates were not something that we considered very seriously at all today. It was not one of our main policy options…

I don’t expect that we’re going to be in a path of providing additional accommodation. But if the outlook were to change in a way that most of my colleagues and I do not expect, and we found ourselves with a weak economy that needed additional stimulus, we would look at all of our available tools. And that would be something that we would evaluate in that kind of context.

Let me decipher this for you. If the US economy continues to weaken it’s all bets off on lower interest rates.

These two charts pretty much tell you the global economy is headed further south and will take interest rates with it.

The dynamic that has driven global growth over the past two decades has been the ‘maker and taker’ model. China was the maker and the Western world consumer (with the aid of a home equity loan and credit cards) was the taker.

The biggest takers were US consumers. Something like 70% of US GDP is generated from consumption.

In that context you’ll see why these two charts tell you where we are headed.

The buying power of US household income (adjusted for inflation to 2014 dollars) has been in steady decline since the late 1990s and especially after the GFC. Without the ability to use their homes as an ATM to increase their buying power, the US consumer is buying less.

Source: Federal Reserve Economic Data

The takers being squeezed is not good news for the makers. For those who don’t know, the McKinsey report released earlier this year stated that since 2008 China has quadrupled its debt from US$7 trillion to US$28 trillion.

The following chart from the recent Daiwa Institute of Research report measures the level of real capital stock (equipment and machinery, used to produce goods to real GDP economic activity).

The chart shows a good chunk of that borrowed US$21 trillion has gone into financing equipment to make more stuff. Stuff the western consumer no longer has the capacity or desire to buy.

With a level of capital stock that is three times the amount of the Chinese economy, it’s a fair guess there is a lot of excessive capacity in the system. Which tells you why there is so much angst on Wall Street at present.

For years I have been saying China is not a miracle it is a mirage…just like the Japanese economy was in the 1980s.

The Daiwa Institute for Research report (with my emphasis) went on to state:

Between the years 2012-15 Chinas economy declined, yet still was able to maintain a high growth rate of over 7%. However, 5%pt of the growth rate was due to the increase in capital stock. Labor input and total factor productivity contributed only 2%pt.

China borrowed with its ears pinned backed to finance machinery to make things there is no demand for. Yes, this activity moves the GDP needle into the positive while the dollars are being sloshed around the system, but then what?

You have a truckload of debt and idle machinery, that’s what. How do you repay your debt with no revenues? You don’t. You default.

This is why the world is getting nervous. The past seven years have been nothing but a sham. A concerted plot to keep the Ponzi scheme in motion.

The economic growth model we have all grown up with and are accustomed to is a fraud. Debt financed growth is an illusion. It cannot last. Eventually you reach a point of peak debt. And I think we are getting perilously close to that peak.

In addition to the Fed not ruling in or out negative rates, there are also some other hare-brained schemes being muted lately by so-called experts. Desperate times call for desperate measures and there are none more desperate to see the growth merry-go-round continue than the banking fraternity.

This is from Macquarie Bank (emphasis mine) suggesting a stimulus injection would help mimic the business cycle:

…why shouldnt public sector bypass markets altogether and inject stimulus directly into the ‘blood stream? Whilst it might or might not be called QE, it would have a much stronger impact and unlike the last seven years, the recovery could actually mimic a conventional business cycle and investors would soon start discussing multiplier effects and positioning in areas of greatest investment.

This is a twist on Bernanke’s ‘helicopter money’. Bypass the banks and put the dollars (freshly printed of course) into the hands of the consumer.

And this priceless piece of economic genius from Willem Butler, Citigroup’s Chief Economist, really does not need any interpretation from me:

A global recession starting in 2016 led by China is now our Global Economics teams main scenario. Uncertainty remains, but the likelihood of a timely and effective policy response seems to be diminishing…

Helicopter money drops in China, the euro area, the UK, and the U.S. and debt restructuring…can mitigate and, if implemented immediately, prevent a recession during the next two years without raising the risk of a deeper and longer recession later.

So folks there you have it.

The Fed (with the worst forecasting record in the world) is forecasting lower US growth rates (so how bad must it really be) which is why they are hinting at negative interest rates. Daiwa Institute for Research is warning about a zero economic growth rate in China. Macquarie are recommending money heroin is needed to put the economy on a mimicked high. And Citigroup see a global recession unless a fleet of helicopters take off immediately, loaded with cash.

For the life of me I can’t figure out why Wall Street should be the least bit nervous. Can you?

The economy is a fake. The market recovery is a fake. The central bankers are a fake. But the economic collapse and capital destruction will be real.


Vern Gowdie

Editor, Markets and Money

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Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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