What the…? No way out at all?
What about the spending, the tinkering, the stimulating, the investing, the debt, the austerity, the innovation and technology, the monetary tools, the politicians, the central bankers, the good intentions, the…hope?
This was the rather sobering conclusion to Satyajit Das’s 90 minute presentation at the World War D conference. Das was dressed for the occasion, wearing all black. And it was a fitting conclusion given he spent the entire presentation explaining exactly why the exits are closed.
In a word, it’s because of debt. There is simply too much of it, and we’re trying to create more of it in the belief that it’s some kind of solution. No wonder Das thinks there’s no way out; we’re trying to exit through the roof. Or as he put it:
‘The low rates, mispricing of risk and excessive debt levels that were the causes of the crisis are now considered the ‘solution’. It is reminiscent of the observation of Viennese critic Karl Krause about psychiatry: “the disease which masquerades as the cure”.’
What about going the other way? Back down the stairs and out through the front door? That’s not likely. The way Das tells it, downstairs is completely flooded.
‘Withdrawing fiscal stimulus would lead to sharp slowdowns in economic activity. Reduction in government services and higher taxes accelerates contraction in disposable incomes, especially in an environment of stagnant incomes and uncertain employment. In turn, this leads to a sharp contraction in consumption. Slower growth, exacerbated by high fiscal multipliers, makes it difficult to correct budget deficits and control government debt levels.
‘ZIRP and QE policies are also difficult to change. Normalisation of interest rates, reducing purchases of government bonds and reduction of central bank holdings of securities risk financial disruption.
‘Central banks may find it difficult to increase interest rates. Reduction of central bank purchases of bonds also risks higher rates and reduced available funding. Low rates allow over extended companies and nations to maintain or increase borrowings rather than reducing debt levels. Levels of debt encouraged by low rates become rapidly unsustainable at higher rates…
‘In 2013, the US Federal Reserve’s tentative ‘taper’ proposal, in effect a slight reduction in bond purchases, triggered market volatility. The 10 year US Treasury bond rate increased around 1% per annum.
‘If sustained, the 1% rise in rates would increase the debt servicing costs of the US government by around US$170 billion. A rise of 1% in G7 interest rates increases the interest expense of the G7 countries by around US$1.4 trillion.’
Oh dear. We’re stuck.
With that horrible potential interest bill in mind, now you might have a better understanding of why the Federal Reserve and other central bankers wheel out their salesman on a weekly basis to reassure the market that official interest rates are going nowhere (even though they can’t really control market rates).
Higher rates mean higher interest expense, and the government finances that expense by either issuing more debt or increasing taxes, which sucks resources from the real economy.
The bottom line is that higher interest rates will cripple the global economy, which is why the market fears Fed tightening so much. So any improvement in economic data that necessitates an end to easy money brings us one step closer to another nasty slowdown. This is why the ‘bad news is good news’ trading pattern has become such a monotonous feature of markets these days.
And if you think that it will be possible to eventually go back to somewhere around ‘normal’ in terms of interest rate settings, Satyajit Das has a stat to prove you wrong. For example, he pointed out that according to a study done by the Bank of International Settlements, a three percentage point increase in global government bonds rates would have devastating effects on the value of outstanding bonds, with losses equivalent of around 8% of US GDP for US bonds or a massive 35% of GDP for Japanese bonds.
But we’re not likely to see such an increase in rates across the globe, certainly not without a major pickup in inflation. So stuck in a low growth, low inflation environment, Das sees ‘QE forever’. To reinforce his point he played a verse from The Beatles’ Strawberry Fields Forever. Along with Leonard Cohen’s, Everybody Knows, it made for quite a unique presentation.
Along with QE forever, or rather as an extension to it, Das reckons we’ll all be subject to financial repression for years to come, which will take two forms. Firstly, governments around the world will increase taxes and decrease services in an attempt to get their finances in order. At the same time their central banks will engineer negative real interest rates in an attempt to inflate their way out of their debt problem.
But Das acknowledges the problems of this approach:
‘Debt monetisation also creates moral hazards. Low rates and easy availability of credit reduces market discipline. Borrowers face less pressure to reduce unsustainable debt. Low borrowing costs allow unproductive investment to be maintained. It reduces incentives for governments to bring public finances under control.
‘Ultimately, the policies being used to manage the crisis punish frugality and thrift, instead rewarding borrowing, profligacy, excess and waste.’
Yep, that’s right. The ‘solutions’ that the pollies are pursuing are exactly what got us into trouble in the first place. It’s a frustratingly familiar story to anyone who’s been following for a while.
But as Das pointed out, the problems that we have are deep seated structural problems, which cannot be solved through the use of fiscal and monetary policy. This is not new ground for long suffering Markets and Money readers. We’ve been banging on about structural versus cyclical problems for some time now, and how monetary policy simply provides a cyclical boost to prices and activity in a structurally deformed world.
And so we come back to where we started…
In a hushed, dramatic tone, Das concluded:
Given the musical flavour of the presentation, we would’ve liked to see Das end with The Doors’ Five to One. After all, there’s a hint of optimism in it. Because for all the hand-wringing and angst about what governments and central banks have done — and are doing — you still control your destiny. They’re not exactly making it easy for you, but the future remains in your hands.
Over to you, Jim…
Five to one, baby
One in five
No one here gets out alive, now
You get yours, baby
I’ll get mine
Gonna make it, baby
If we try
for Markets and Money
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