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Sick on Credit

The credit boom chickens are coming home to roost...
 
THAT ROARING sound you can hear is the noise of chickens coming home to roost across the western world, writes Tim Price at his Price of Everything blog.
 
We have had four decades since President Nixon took the US dollar off gold in 1971, during which time our politicians have happily promised us the earth and made up for the inevitable shortfall by borrowing from the bond markets, and therefore from the future. But even governments cannot live beyond their (taxpayers') means indefinitely. As the likes of Greece and Sicily are now discovering, the future has caught up with us.
 
There is a thesis, with which we agree, that suggests that the world now requires constant economic growth solely to service its mountain of outstanding debts. So what happens when that constant economic growth starts to turn into a synchronized slowdown – or worse? So far, with private sector borrowers furiously deleveraging (even at near zero interest rates: NOBODY WANTS TO BORROW – see Japan, last 20 years), the major central banks have aggressively taken the other side of the trade, and pumped money into the banks through the magical money-creation Ponzi scheme known as quantitative easing.
 
The banks aren't particularly keen on lending it out. That may be because they're predominantly insolvent, but let's not go there. So we have a stand-off, of sorts. On the one hand, individuals and corporates, having binged on easy credit for far too long, are now mostly sickened by the stuff. On the other hand, central bank governors don't want to take the credit for Great Depression II. They'll get it anyway, because the markets cannot be fooled indefinitely either. Meanwhile, the price signals that would ordinarily be a guide to entrepreneurs and other risk-takers are being hopelessly distorted by money-printing.
 
One side-effect of QE is that increasingly dangerous sovereign debt (as a shorthand: G7 government debt) optically resembles high quality debt in that the miserly yields available seem to reflect some form of 'flight to quality'. What those miserly yields actually reflect is financial repression – namely that the government and its regulators are effectively forcing captive investors (not least pension funds) to invest almost exclusively in this garbage. In the process, by happy coincidence, heavily indebted governments are able to fund themselves. The private sector has a word for this policy: extortion.
 
Another side-effect of QE is that the perception of value in the variously affected currencies swings even more wildly than usual. Somebody intelligent once wrote that paper currencies don't float, they just sink against each other at different rates. Since 1971 this has undoubtedly been the case. But since the Fed and the ECB went all-in in their pursuit of QE ad absurdum, the risk of disorderly currency collapse has risen markedly.
 
Don't just take our word for it. CLSA's Christopher Wood in his recent 'Greed and Fear' commentary writes as follows:
 
While the central banks have undoubtedly bought some time by creating the newsflow to allow most world stock markets to rally last quarter after the Eurozone-driven risk-aversion seen in the previous quarter, the decision by the Fed to adopt "open-ended" QE, and the overwhelming reaction of the investor consensus to support that decision, has re-enforced the base case long argued by Greed & Fear. That is that the "capitalist" world is on the path to the collapse of the fiat paper system. For once the "open-ended" principle is established, as it now has been, it can be expanded ad infinitum.
 
The game will be up when investors cease viewing the relevant sovereign bond as a safe haven and that government bond yields spike as a result of supply concerns. At the point when such turmoil hits the reserve currency of the world, namely the US dollar and its government bond market, quantitative easing will be discredited, and most likely the modern fiat paper monetary system along with it, as well as of course monetarist and Keynesian orthodoxies.
 
Nor is Christopher Wood alone in a financial wilderness in this bleak prognosis. SocGen's Dylan Grice in last week's 'Popular Delusions' commentary cited Bernd Widdig and his analysis of Germany's inflation crisis ('Culture and Inflation in Weimar Germany'):
 
Next to language, money is the most important medium through which modern societies communicate.
 
As Dylan Grice indicates,
 
His may be an abstract observation, but it has the commendable merit of being true.. all economic activity requires the cooperation of strangers and therefore, a degree of trust between cooperating strangers. Since money is the agent of such mutual trust, debasing money implies debasing the trust upon which social cohesion rests.
 
And he adds,
 
I feel queasy about the enthusiasm with which our wise economists play games with something about which we have such a poor understanding.
 
For students of markets and economics this recalls a quotation by Keynes himself:
 
But to-day we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time — perhaps for a long time.
 
Keynes also once wrote that he worked for a government he despised for ends he considered criminal. We would adopt that phrase and direct it to the leading neo-Keynesian economists – overzealous believers in a false science – who are even now leading the delicate mechanism of the western economies into a fatal experiment with unsound money, egged on by bankers whose ethical compass has already been shown to be hopelessly compromised.
 
Today the currency of Iran. Tomorrow ..?
 
This argument happens to transcend the mundane and partially subjective business of shepherding pounds, shillings and pence to the safest havens; it touches on issues of fundamental morality. If we are debating with the ignorant, ignorance can ultimately be addressed, given an open mind. If we are debating with the profoundly stupid, that stupidity may admittedly be a barrier to full resolution of the debate. But if we are debating with people who are going to do harm, whether deliberately or inadvertently, the debate should be conducted at the fullest volume and with the widest number of engaged participants.
London-based director at Price Value Partners Ltd, Tim Price has over 25 years of experience in both private client and institutional investment management. He has been shortlisted for the Private Asset Managers Awards program five years running, and is a previous winner in the category of Defensive Investment Performance. Tim regularly shares his views on his blog, The Price of Everything.
 
See the full archive of Tim Price articles.

 

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