Artwork: Ilargi for The Automatic Earth
That thing in Davos is on again, the World Economic Forum, sort of like the Academy Awards without awards but with the same peacock factor. And snow. Full of business leaders and government leaders and media leaders, the vast majority of whom are the same folks who attended before this crisis broke you but not them into pieces, and easily enough to make you realize with a shudder what an unmitigated disaster it is that these are the people who are supposed to take the world back to financial health. Simply because they are the people who profit most from the state of the world as it is, or they wouldn't be there. And they are the chosen ones destined to save you? They are only out to save themselves.
One of the people always present, well, actually, he's a bit of a new addition to the flock who rose to claim and fame because of the crisis, is Nouriel Roubini. And at first sight, you may think: why is he there? He's Dr Doom after all, he has what may look like negative messages for the in-crowd, so why welcome and tolerate him? And then you understand what Roubini's role is.
He's as vain as the others, and he gets paid really well to play his role in the grand scheme. That is to say, Nouriel is the court jester. Every ruler needs someone to make fun of him/her. That creates the impression that (s)he can laugh at him/herself, an indispensable quality if one wishes to impress one's guests. A sign of strength indeed.
The media have continued quoting Roubini for 5 years now, even though he's said a lot of quirky things since he became their darling. He's quoted because he predicted the crisis, yeah, but so did quite a few other people, including ourselves here at The Automatic Earth. So that's not the whole story.
Why then do we find Roubini again in Davos? Because he says things that may sound doomerish and critical, but never in a way that would make the rich and powerful he hob-nobs his way into increasing wealth with uneasy. Sure, they don't like what he says, but they also don’t believe most of what he says. We've all lost track of the number of times through the years that Roubini has – literally – said there's a perfect storm coming just around the corner. So much so that "perfect storm" no longer means anything if coming from him – if it ever did in the context -.
That said, there was something he said last week that does deserve some attention, albeit more or less despite himself. The upside is, Roubini had a good idea. The downside is he got it wrong.
Speaking at the World Economic Forum in Davos, Davide Serra, founder of leading hedge fund Algebris, and Nouriel Roubini, the head of Roubini Economics known as Dr Doom for predicting the financial crisis, set out the case against those who think quantitative easing (QE) and low rates are benign policy tools. "When governments borrow, they are taking money from our children. QE is the same – we are lowering returns for future generations. QE creates an inter-generational dilemma," Mr Serra said.
Mr Roubini warned that central bankers need to think about turning off the cheap money tap or risk creating another, possibly even worse, bubble. He argued that policymakers have encouraged markets and individuals to take on crippling levels of debt by leaving asset bubbles unchecked in a boom and coming to borrowers’ rescue in a crisis. [..]
He said loose monetary policy is creating a system biased to creating bubbles, "that's why we've been moving to more unconventional territories" in policy responses – from low rates to QE to credit easing.
"Central bankers have affected the behaviour of the private sector. They have to think about that," he said. "As you do a slow exit out of QE you may create another bubble and make another crisis. "At some point, the consequence of postponing deleveraging is that you end up with zombie banks, zombie companies, zombie households, and zombie governments."
Roubini has identified the fact that there was a crisis, as it was building up, but he's never understood what brought it about (well, either that or he's not telling). The crisis creates zombie everything, he's got that right, but what he doesn't get is that this happens because bailouts and QEs spread around zombie money.
"… the consequence of postponing deleveraging is that you end up with zombie banks, zombie companies, zombie households, and zombie governments." Roubini doesn't identify why that is. Which is that you can only postpone deleveraging with zombie money. In a sense, he himself is a zombie.
Zombie money is what you're left with if you don't restructure debts and financial institutions. If you don't do that, any public money you provide to banks through QE or other stimulus measures is not real in the sense that it can be freely spent or lent out, because at the other end of the ledger it's balanced out (and more) by the unrecognized losses that remain in the books. As long as there's no restructuring, it may plug holes below ground, but because of the size of the holes, above ground it builds only zombies. That is the essence of the financial crisis, and none of it has been resolved.
The only thing that keeps the zombie money from falling through the floor and into the holes is faith, hope, charity and make-believe. Yes, it keeps things going in a more or less acceptable-looking manner if you don't look too close, and yes, it makes the "right people" money, but in the end its most important effect will be procrastination, and that will come at a huge cost. We should be restructuring, but we don't. Those who would stand to lose most in a thorough restructuring of financial institutions are the same "right people" who make money by refusing to restructure.
There is no mystery here. A government or central bank, or both, can resort to QE and bailouts, and do some good, provided they are temporary measures that are balanced out through restructuring. And that they are aimed at relieving pressure for the people in general (whose money pays for it all), not the stakeholders in the very institutions that are being bailed out. We are more than 5 years into this thing and not as much as a second hand car has been marked to market. In fact, the whole concept sounds so foreign by now you can be sure hardly anybody knows what it means anymore.
Another Davos stalwart, Stephen Roach of Morgan Stanley Asia, also mentioned zombies in an article for Project Syndicate, which makes a bit – but only a bit – more sense:
From the first quarter of 2008 through the second quarter of 2012, annualized growth in [US] real consumption spending has averaged a mere 0.7%—all the more extraordinary when compared with the pre-crisis trend of 3.6% in the decade ending in 2007.
The disease is a protracted balance-sheet recession that has turned a generation of America’s consumers into zombies – the economic walking dead. Think Japan, and its corporate zombies of the 1990s. Just as they wrote the script for the first of Japan’s lost decades, their counterparts are now doing the same for the US economy.
[..] Steeped in denial, the Federal Reserve is treating the disease as a cyclical problem—deploying the full force of monetary accommodation to compensate for what it believes to be a temporary shortfall in aggregate demand.
The convoluted logic behind this strategy is quite disturbing—not only for the US, but also for the global economy. There is nothing cyclical about the lasting aftershocks of a balance-sheet recession that have now been evident for nearly five years. Indeed, balance-sheet repair has barely begun for US households. The personal-saving rate stood at just 3.7% in August 2012—up from the 1.5% low of 2005, but half the 7.5% average recorded in the last three decades of the twentieth century.
Moreover, the debt overhang remains massive. The overall level of household indebtedness stood at 113% of disposable personal income in mid-2012—down 21 percentage points from its pre-crisis peak of 134% in 2007, but still well above the 1970-1999 norm of around 75%. In other words, Americans have much farther to go on the road to balance-sheet repair—which hardly suggests a temporary, or cyclical, shortfall in consumer demand.
[..] Just as two previous rounds of quantitative easing failed to accelerate US households’ balance-sheet repair, there is little reason to believe that "QE3" will do the trick. Quantitative easing is a blunt instrument, at best, and operates through highly circuitous—and thus dubious—channels. Significantly, it does next to nothing to alleviate the twin problems of excess leverage and inadequate saving. Policies aimed directly at debt forgiveness and enhanced saving incentives—contentious, to be sure—would at least address zombie consumers’ balance-sheet problems.
Moreover, the side effects of quantitative easing are significant. Many worry about an upsurge in inflation, though, given the outsize slack in the global economy—and the likelihood that it will persist for years to come—that is not high on my watch list.
Far more disconcerting is the willingness of major central banks—not just the Fed, but also the European Central Bank, the Bank of England, and the Bank of Japan—to inject massive amounts of excess liquidity into asset markets – excesses that cannot be absorbed by sluggish real economies. That puts central banks in the destabilizing position of abdicating control over financial markets. For a world beset by seemingly endemic financial instability, this could prove to be the most destructive development of all.
That's all fine and well, and Roach provides some interesting numbers, but he doesn't address the core of how zombified the US economy has truly become. Roach names America's consumers as zombies, but not its banks (or other companies and institutions), perhaps due to his own job description. And while one might argue that this is due merely to Mr. Roach focus in this particular piece, it does at the same time prevent one from fully comprehending the issues at hand.
When Roach talks about the "massive amounts of excess liquidity" injected by central banks, he fails to mention that these amounts were never – primarily – aimed at remedying household debt. Similarly, where he writes:"Just as two previous rounds of quantitative easing failed to accelerate US households' balance-sheet repair, there is little reason to believe that "QE3" will do the trick", he tempts his reader to overlook the fact that QE was never meant to repair household debt.
Zombie banks become what they are because their debts are too large for them to overcome, pay off, conquer. Throwing massive amounts of stimulus money at them can by definition only work if the banks' debts are restructured at the same time, and to an equal standard. This has not been done, and to this day still isn't, because such restructurings bring about large losses for the banks' stakeholders, and it's these stakeholders have as strong and rich a hold on political power as they have on the banks. This political power enables them to evade their own losses and use public money to keep the banks afloat.
But they can't live in a world replete with zombies anymore than the less fortunate can, though they don’t understand that this is so, or why that is. A rich owner of a zombie bank in the end can only be, turn into, a zombie him/herself. The worst may hit the poorer a bit earlier, but then, we all have kids.
There's a striking similarity with how we all live in this world where we "harvest" all resources we can lay our hands on and kill off much of the natural world in the process, totally oblivious to the obvious fact that we have developed the way we have because that natural world was composed of the elements it was, and there is no guarantee we will survive in the world we create by driving millions of these elements into extinction. But that's topic for another day.
What people like Roubini and Roach, along with most of the financial world and hangers on (re: Davos), don't see, quite likely because their livelihoods depend on them not seeing it, is that through trying to save their own world by allowing public funds to turn into zombie money, i.e by not restructuring debt, down the line they hold only zombie money and themselves turn into zombies.
Roubini states that we WILL end up with "zombie banks, zombie companies, zombie households, and zombie governments", but he gets his timing wrong – it's already happened – and he doesn't understand why. He gets close, though, got to give him that, saying that it's: "…the consequence of postponing deleveraging". Still that's merely part of the story. What Nouriel doesn't mention is that we can only postpone deleveraging by turning trillions of dollars of the public's funds, and their children's, into zombie money, the kind designed to cover bottomless pits to such a degree you think we can all of us walk on water.
Stephen Roach talks about the failure of QE in repairing Joe Blow's finances (household debt), but neglects the reality that no QE was ever intended to do that. In fact, it's exactly because Joe and Jill Blow's – and their children’s- money is used not to save them from ruin, but to save the banks that rule their world, that their money has gone zombie. As in not real, perhaps appearing to be real, but in essence empty and out for your blood.
It's attractive and tempting to watch all the news and opinions on offer right now that promise you recovery, but there's no substance in them, they're as zombie as the economy they try so hard to celebrate. It really is simple: The debt is still there, nothing's been fully marked to market, all that's happened over the past five years is that your money has been used to cover up a whole bunch of bottomless holes. And precisely and ironically because it's your money has been used for the cover up, it's your children who are going to fall into those holes.
We can either opt to deal with reality or accept that we continue to roam our lives as the zombies we now are. And yes, we do still have that choice.