Photo top: Dorothea Lange Broke, Baby Sick February 1937
"Tracy (vicinity), California. U.S. Highway 99. Missouri family of five, seven months from the drought area. Broke, baby sick, car trouble."
Little by little the realization is seeping through that, provided we can agree a recovery cannot be purchased outright, there is no such thing as a recovery anywhere in the western world. Mind you, I said seeping, and I could even have said trickling; it's a slow process. And that is a direct consequence of various vested interests in producing the illusion of recovery and growth which exist in the realms of politics, finance and media.
A few days ago, in the shadows of its revelations concerning Edward Snowden, The Guardian – in its Sunday sister The Observer – ran another piece that warrants scrutiny. The core line in it is this:
Trying to solve a debt problem with more debt has created a bigger bubble, (and it's hard to see what the central banks can do).
(The core term in it of course is "stonking crashes", I love that.) And then Wednesday Jill Treanor, also for the Guardian, quoted Bank of England director Andy Haldane:
"Let's be clear. We've intentionally blown the biggest government bond bubble in history … "
Combine the two, and you get a peek into the reality of what moves our economies these days, and it's not a pretty peek once you think it through. It shows you that all the talk of recovery is just empty air, whether you're in Europe, Japan or the US. That is, again, if we can agree that a recovery cannot be purchased. i.e. that you cannot solve a debt problem with more debt.
As reasonable as this may sound, it's not something everyone will easily agree to; there's a whole camp around Paul Krugman that would disagree. What they don't understand is that no amount of stimulus can lead to a real recovery if the initial debt levels are too high, because you would need to achieve absolutely miraculous growth levels just to avoid being overrun by interest payments. Such growth levels are nowhere in sight. That means that the bottom line of Bernanke's QEs and Draghi's OMT and Japan's Abenomics will prove to be just another transfer of public funds to the private sector disguised as measures to benefit the general public.
It seems obvious enough these days in Japan. The third "arrow" of Abenomics won't arrive until autumn, and already lots of disappointed questions are being asked about the entire program, but Bank of Japan chief Kuroda still came out to say the BoJ won't do anything right now. Sure, the Japanese GDP number looked somewhat alright, but how fleeting is that? Perhaps what we should read into this is that Japan will not act until it's absolutely if not tragically necessary, simply because it's gotten stuck in a no-man's land located between interest rates and bond yields. The Bloomberg headline "Kuroda Stares Down Bond Volatility" speaks volumes in that regard; "Kuroda Stares Into Headlights" would have been a much more appropriate choice.
And maybe this is a good moment to revive the strangely silenced discussion about the importance of central bank independence. Not a soul has talked about it for a long time now, not when it comes to what Abe and Kuroda are concocting. When Hungary PM Victor Orban last year proposed laws to draw the central bank closer to the government, he was accused of every sin known to mankind, and the EU wanted to take him to court and impose all kinds of sanctions, but now Japan dissolves all barriers between its government, its central bank, and now its largest pension fund, nary a word is heard. And of course Ben Bernanke doesn't have an inch of independence left in him either; he's a tool to transfer taxpayer funds to the private sector, because that's the only source of profit for that sector.
It's becoming increasingly obvious to an increasing number of people both inside the finance community and outside of it that the financial markets we see today exist only by the grace of central banks buying various shades of paper. If these no longer independent but instead highly politicized institutions would start to purchase less bonds or derivatives such as MBS, what is presently advertised as a recovery would disappear in the wink of an eye, and reality would set in once more.
Since neither the central bankers nor the financial community are responsible for paying down the debt these purchases add, and those who will have to pay – the people of the countries involved – have no political ways of halting the practice, the QEs and other stimulus measures may go on for a while. But that won't help the illusionists either, because their purchase schemes come with their own inbuilt demise. And that is what we're starting to see lately.
In the words of the Guardian:
During the past four centuries, there have been five occasions when major credit bubbles have led to stonking crashes. Tulip mania in 17th-century Holland was the first; the South Sea bubble in the 18th century was the second; the US real estate crash of the 1830s was the third; the 1929 Wall Street Crash and the Great Depression was the fourth. The sub-prime crisis that began in 2007 was the fifth.
As the world approaches the sixth anniversary of the freezing up of credit markets, a terrible idea has occurred to investors: we might only be part-way through the crisis. This has come as something of a shock. For the best part of the year markets have been pushing asset prices higher in the belief that the worst of the crisis is over. They have given a big round of thanks to Ben Bernanke, Sir Mervyn King et al for keeping monetary policy ultra-loose and avoiding a repeat of the 1930s.
Doubts are now starting to set in, and rightly so. Cheap credit has done wonders for equity and bond markets but precious little to revive real activity. This has been the weakest recovery from a slump in living memory. And financial markets have become dependent on central banks keeping the money taps wide open, even though the evidence is that each additional dose of easing is less effective than the last.
[..] An extremely aggressive and highly dangerous dependency culture has developed and it is not easy to see how central banks get out of the problem that they have created for themselves.
There is clearly a risk that if the Fed, the Bank of England, the ECB and the Bank of Japan started to nudge up interest rates towards pre-crisis levels and gradually reversed QE, over-leveraged households and banks would not be able to cope. Yet, there is also a risk that seeking to solve a debt problem with still more debt is creating the conditions for an even bigger bubble, which could go pop at any time.
Support for this idea is growing. John Kay noted last week that the world was heading for a second crisis because the financial sector was inherently prone to instability. "Prices are driven to silly levels, but everyone makes a load of money in the meantime, and then you get a correction."
[..] Charlene Chu at Fitch has noted that total lending by banks and other financial institutions in China was almost 200% of GDP in 2012, up from 125% four years earlier. Not only is credit twice as big as China's economy, it is growing twice as fast. [..] debt-fuelled growth on this scale can work for a while but eventually proves unsustainable as debts become unpayable.
[..] Europe's banks are pretty much insolvent and kept going only by unlimited liquidity provided by the ECB. What's more, they are far bigger in relation to the size of the eurozone economy (350% of GDP) than are the American big banks (80% of GDP).
[..] … something very nasty is lurking out there. Investors would do well to take note.
No matter what happens next, the chance that central banks will be able to continue to manipulate down both bond yields and interest rates is getting slimmer by the day. Nonetheless, they'll keep on doubling down on their bets: the more they lose control (or the more it's obvious they never had any), the bigger the losses for the financial community will get, and the more they will clamor for more stimulus.
And though in theory – relatively – low rates and yields could be accomplished as a consequence of economic growth, in this instance that is obviously not the case. Instead, yields and rates rise for the simple reason that investors fear they will rise. And that is a mechanism, especially because it happens in the middle of the biggest stimulus spending in history, that will prove extremely hard to suppress.
Abenomics is already being recognized as desperate, and that can't work in a game based entirely on confidence, or even just the perception of it. And with confidence in Abenomics fading, who will continue to believe in the Fed's QE? They're from the same illusionist handbook. As for the ECB's chapters from that book, the German courts may take care of those even before the markets do. Bundesbank head Jens Weidmann said in court this week that – in part because of the case in front of the German Constitutional Court – the ECB cannot give an absolute guarantee it will be able to keep purchasing. That may be enough to sink the whole enterprise.
The finance community has increasingly come under the illusion that in reality they are the economy, and drawn a large part of the deluded public with them, but the real economy is still driven not by banks and investors, but by the 70% of GDP that depends on consumers. Whose debt rises with every bond their central bank purchases, whether they're told so or not.
Or the finance community may fool themselves into believing that at least when they are doing – relatively – well, the real economy will also be better off, but that's not true either. The opposite is true: the financial world is doing well at the cost of the consumers responsible for 70% of GDP, since everything finance would be a disaster if not for the stimulus measures paid for by today's consumers and their progeny.
Everybody in finance understands that piling more debt onto a system drowning in debt is at the very least a risky adventure. But they are not the ones bearing that risk, so why should they care? And those who do carry the risk, the population at large, continue to float somewhere between ignorance and gullibility until it's too late.
We can reach the end of this game in one of two ways. First, the people in the streets can call a halt to the illusionary circus that has become our financial system, by refusing to have more of their wealth transferred to the private sector. Since this hasn't happened to date, it's probably more likely it will end the second way: Since stimulus is not just an addiction, but one that requires ever more of the fix provided, and there is no limitless supply of it, interest rates and bond yields, which have been held at historic lows at great cost to society, will rise as the financial community will increasingly demand returns on investments.
You can restructure debt on a voluntary basis; we haven't done that, we've instead chosen to hide it as far and as deep as possible. But it will be restructured – and defaulted on – regardless: higher interest rates and sinking bond prices will inevitably and inexorably start to draw bad debt from its hiding places. Therefore, the tangible desperation of Abenomics simply hastens a process which would have happened anyway.
It's a shame for the people in the street that it must come to this, because the costs for them will be many times higher than if they had made their voices heard earlier. But perhaps, given the entanglement of governments, central banks, the financial community and the media, this was unavoidable.
What's positive for those people is that it means the entire investor model of the economy as we know it is dead (though I don't think many are ready to accept this), once it's obvious it was only held standing up through ever larger injections of taxpayer funds. At least they won't have to worry so much about vultures picking at the carcasses of their lives, even as these lives will in most cases be pretty destitute.