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02 January 2014

A Sinking Ship

Ever since the 2008 financial crisis collaterally damaged the hull of the financial “supertanker,” overly indebted governments have been struggling to right the over-leveraged and listing financial system, and have clearly not been able to steer it in any other direction. As economic and monetary contraction started apace after the US sub-prime mortgage bubble popped creating a wave of global banking insolvencies, western governments and central banks cobbled together a plan to refloat the banking system. As asset prices started to drop and deflationary forces took hold, central bankers warned of a complete collapse of global finance and thus a societal collapse. Their subsequent actions now five years on should be assessed; so, has anything actually been achieved by the centrally planned rescue effort? Or are the policies pursued a futile exercise that will end in disaster?

Quantitative Easing - Part One

QE is a monetary expansion policy tool that created a bailout mechanism for the banking sector in the wake of the sub-prime crisis. It was the first shot fired in the “war” to save the current monetary system. It was orchestrated by the US Central Bank (the Fed) whereby banks and major corporations (through the troubled asset relief program - TARP) globally received billions upon billions of new money in return for failing assets. This injection of liquidity helped initially to maintain implied solvency of the system; however, all that has actually been achieved is that the central banks now hold a significant proportion of the bad debt on behalf of Governments and ultimately tax payers (adding to national debts). The new money received by the banks was used to re-inflate asset prices to save the system, but has also maintained the gambling-and-champagne lifestyles of the privileged bankers.

QE, it would appear, has not solved anything; rather, it has just pushed the problem into the future. Nominal asset values are held steady in order to maintain solvency; however, at some point in the future, the central banks will have to sell the assets they are now holding. If they were to fail to get good value for those assets, then the central banks themselves would need a bailout. This could be achieved by a simple balance sheet exercise - the cancellation of the debt/asset leaving just the liability of the freshly printed money. Pure and simple debt monetization or as central bankers call it “unsterilized “money creation. Starting the process of QE is the easy bit, getting out as we will see may just be impossible.

Sovereign Bailouts

While sub-prime was busy undermining the global banking world, bailouts to the financial sectors of individual countries were adding more debt to already overly indebted governments. Government debt levels were extremely high around the world, but particularly in Europe due to years of deficit spending. The southern European countries (PIGS) had not controlled their deficit spending obligations under the Maastricht Treaty and were thus in danger of default as sovereign bond yields went sky high. Of course, many of the creditors of the sovereigns were the global banks that held Government debt as collateral. This was undermining the over-leveraged banks from a different angle. Even though some creditors had to take “haircuts”, the bailouts added much more debt to these countries so that zombie states have now been created. Impoverishing populations by austerity and debt servitude has been the order of the day, but also, by being trapped in the strait jacket of the Euro, they have been unable to restart their economies via currency devaluation. Thus only structural and fiscal reforms are open to them, sending these economies into 1929 great depression style deflations. Iceland’s approach in comparison to the likes of Greece et al has been more successful, albeit on a much smaller scale. A straight default and an inevitable devaluation of its currency has left it weak, but in charge of its own destiny, and it is very much on the way to being productive after its flirtation with failure due to over financialisation. It has also been jailing the main banker culprits in its financial downfall.

This would seem the correct approach, but in this world not all countries and people are equal. The US, the UK and Japan, to name but three, are using mainly monetary policy to try to solve the problems with a large dose of financial repression thrown in. (A policy of financial repression, although not stated, occurs when low nominal interest rates (ZIRP – zero interest rate policy) can reduce debt servicing costs, while negative real interest rates erode the real value of government debt.)

Quantitative Easing - Part Two

Current levels of QE are outrageous particularly in the US and Japan. As stated through the concept of financial repression, the reality of the present QE policy is about currency devaluation and inflation. To weaken one’s currency in order to import inflation through international trade is in real terms to reduce the debt burden. This is different from the initial reason QE was used when the first bailouts of 2008 occurred. As I stated earlier, getting out of the policy is proving very difficult for central banks as they now seem to be the buyers of last resort in the bond markets as surplus countries are moving away from buying debt, particularly in US dollars. Why hold debt that is constantly being devalued? The UK is probably not too far behind with debasement policy; it may be suggested that the Bank of England will before long be pushed to devalue sterling further by another round or two of QE. We will be told that we need to boost our export sector, but with an ever increasing national debt, currently at £1.2 trillion, we will need to squash interest rates down to keep our debt servicing costs as low as possible.  Of course, by creating a negative real interest rate we are also reducing the savings of a nation. This could be considered yet another form of taxation.

The long-awaited “taper “in the US has now finally occurred; however, a very definite contradiction of policy has been shown up. At the same time as a reduction of asset purchases was stated, it was also stated that ZIRP would be maintained. Based on this low interest rate policy, the Fed will more than likely have in the near future to reverse the taper as bond yields increase making their debt servicing cost on $17 trillion unsustainable. It would seem that for the time being, centrally planned manipulated markets are with us to stay.

What Can We Look Forward To?

What has become evident with all of these seemingly futile policies pushing the problems into the future is that overall inflation hasn’t been as forthcoming as has been needed really to debase the overall debt loads. Therefore one-off wealth transfers in the form of bailins a la Cyprus are waiting in the wings. Instead of stealing peoples’ and corporations’ wealth via stealth inflation over the long term, why not just extract it from their bank accounts in the form of a one-off tax? Coming to a country near you soon, “BAILIN” will be the new political buzzword. Thus, any one with cash in a bank over and above the government insured sum will be at risk of losing a fair percentage of that money.

This type of action of course does nothing to solve the structural economic problems of, for example, off-shoring and corporate tax evasion being faced by indebted governments. It again just buys time. This type of “futile” event may just again tip western societies into the sort of social unrest we have already seen in countries like Greece, Portugal and Spain and across the Arab world with the Arab spring.


There appears no end to the mad interventions that Governments and Central Banks have to take in order to maintain the integrity of the financial system which since 2008 has grown in scale, complexity and danger. All policies are clearly designed to prolong the current system of continual expansion and growth which has become evidently impossible. The problem with this model is that it has stopped working and has now quite literally turned into a Ponzi scheme. The broken system requires changing before the monetary authorities destroy what is left of the remaining capital of the people. It is time we allowed free markets to be free and let the creditors take the hit for their bad investments. It will be a painful transition but ethically we must do what is necessary for future generations to flourish rather than be lumbered with the erroneous debt that has been building up for the last four decades (but particularly since 2008) on the back of a currency system that has now failed. We are but a moment away from the next “Black Swan.”   

This article is written by Richard Horswill. All views expressed are strictly his own.  

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