Monday 1 May 2017 The one stop source for free breaking news, expert analysis, and videos on AIM and LSE listed shares

The economist understands what the politician does not want to admit

By David Scott | Monday 13 March 2017


In a monetary system, like ours, when money is nothing as is it is not backed by anything, Central Banks can produce and controlled money largely at will. This has allowed governments to act like a common counterfeiter, producing money out of thin air to fund its own spending programs and/or reward its supporters, all at the expense of society as a whole. It is much easier to fund wars and welfare out of printed money than taxes, or borrowing from real savings. The steady erosion of money's purchasing power hits retirees the hardest, diminishing their ability to plan for a retirement of comfort and dignity.

The Austrian theory of economic thought puts fiat money expansion as the root cause of the boom/bust cycle that misallocates and eventually destroys capital. The very thing that has happened since 1971, when the dollar gold peg was temporarily suspended by the American, thereby dismantling the global monetary system that had been in place since 1944 and Bretton woods. A system designed to replace the previous gold standard which had underpinned global trade since industrial revolution, when global trade started.
The spring Budget of 2016 outlined borrowing of £38bn during the four years from 2017 to 2020 inclusive, with the UK running a surplus during the last two years of that period. Last week’s Budget projected borrowing over that same four-year period of £141bn, more than a three, and fold increase. On these numbers, our annual deficits will continue for another decade, until 2026, with Hammond abandoning even the pretence of living within our means and now the global interest rate cycle has turned, with our national debt growing ever larger, the £50bn the Government spends on debt interest – more than on schools – can only go up.
In a another salvo against the strong dollar last week there are  reports that during his first appearance at this week's G,20 meeting in Baden-Baden, Germany, Treasury Secretary Steven Mnuchin plans to drive home the message that the U.S. won’t tolerate countries that engage in currency devaluation to gain an edge in trade, a statement which would clearly be a u turn on Mnuchin's recent praise for a stronger dollar, and provides further evidence that the Trump administration's preliminary focus will be on getting the dollar weaker, not stronger, which may in turn impact the Fed's decision, making, especially if indeed Yellen hopes to hike rates three (or more) times in 2017.Mnuchin is also likely to say that the American trade deficit is a sign other major economies aren’t doing their part to support global demand, making the world’s economic growth unbalanced.

While this is a long-standing U.S. grievance, US trading partners are on the lookout for signs that this position is hardening in the context of a stronger dollar, especially toward Germany, which last year ran a trade surplus of more than 8 percent of its gross domestic product. If Mnuchin advances this argument further in Germany, he’ll find himself at odds with fellow Goldman Sachs alumni Mario Draghi. The European Central Bank president on Thursday rejected the Trump administration charge that Germany is manipulating its currency, the euro, which is shares with 18 other countries, and defended the G20 status quo. “It’s quite important that the G20 reaffirms this commitment,” Draghi said at a press conference in Frankfurt. The consensus against protectionism and in favour of market based exchange rates “have been pillars of world prosperity for many, many years,” he said.
Investors in the present climate would be better off preserving capital rather than fixating on high returns, bond guru Gross told clients Thursday. In his latest monthly take on the markets, Gross worries over the explosion of credit since the financial crisis, up to $65 trillion total in the U.S. now, with $12 trillion coming since 2007, according to his count. Making sure that doesn't come toppling down is the job of central banks like the Federal Reserve, which Gross said has done a good job so far of walking a tightrope but faces a perilous task ahead. The Fed has to make sure that interest rates aren't too high to make the cost of capital prohibitive or too low to thwart returns for savers, pension funds and insurance companies. Courtesy of His latest monthly letter "Shoe Me The Money", here are some of his perspectives on the only thing that has kept the global economy going since the financial crisis: debt, and lots of it,"I 2017, the global economy has created more credit relative to GDP than that at the beginning of 2008's disaster. 

In the U.S., credit of $65 trillion is roughly 350% of annual GDP and the ratio is rising. In China, the ratio has more than doubled in the past decade to nearly 300%. Since 2007, China has added $24 trillion worth of debt to its collective balance sheet. Over the same period, the U.S. and Europe only added $12 trillion each. Capitalism, with its adopted fractional reserve banking system, depends on credit expansion and the printing of additional reserves by central banks, which in turn are relent by private banks to create pizza stores, cell phones and a myriad of other products and business enterprises. But the credit creation has limits and the cost of credit (interest rates) must be carefully monitored so that borrowers (think subprime) can pay back the monthly servicing costs. If rates are too high (and credit as a % of GDP too high as well), then potential Lehman black swans can occur. On the other hand, if rates are too low (and credit as a % of GDP declines), then the system breaks down, as savers, pension funds and insurance companies become unable to earn a rate of return high enough to match and service their liabilities. Central banks attempt to walk this fine line – generating mild credit growth that matches nominal GDP growth – and keeping the cost of the credit at a yield that is not too high, nor too low, but just right. Janet Yellen is a modern day Goldilocks.

How is she doing? So far, so good, I suppose. While the recovery has been weak by historical standards, banks and corporations have recapitalized, job growth has been steady and importantly – at least to the Fed – markets are in record territory, suggesting happier days ahead. But our highly levered financial system is like a truckload of nitro glycerine on a bumpy road. One mistake can set off a credit implosion where holders of stocks, high yield bonds, and yes, subprime mortgages all rush to the bank to claim it’s one and only dollar in the vault. It happened in 2008, and central banks were in a position to drastically lower yields and buy trillions of dollars via Quantitative Easing (QE) to prevent a run on the system. Today, central bank flexibility is not what it was back then. Yields globally are near zero and in many cases, negative. Continuing QE programs by central banks are approaching limits as they buy up more and more existing debt, threatening repo markets and the day to day functioning of financial commerce. I'm with Will Rogers. Don't be allured by the Trump mirage of 3 4% growth and the magical benefits of tax cuts and deregulation. The U.S. and indeed the global economy is walking a fine line due to increasing leverage and the potential for too high (or too low) interest rates to wreak havoc on an increasingly stressed financial system. Be more concerned about the return of your money than the return on your money in 2017 and beyond."
Nothing has really changed since the 2008 09 crisis. Low interest rates has encourage borrowing. Artificially low capital costs has allowed unsustainable businesses to continue, generating sub-standard returns. Companies seek quick fix solutions to the complex problem of earning adequate returns by reengineering their finances, rather than improve and bettering the operations of the business.Governments have also increasingly borrowing and adopting private sector financial engineering techniques to deal with economic problems. Governments have increased their debt levels, in some cases resorting to forcing purchases of bonds by central banks, domestic banks, and captive institutions such as state pension funds. Conventional and innovative monetary policies have supported aggregate demand and helped maintain economic activity in the hope of preventing even deeper recessions. The Bank of England currently owns a third of the UK’s national debt, bought with money it has printed. 

Policies that have sent both real and nominal interest rates to ultra-low levels have resulted in a massive redistribution of global income and wealth. According to a 2013 report from the McKinsey Global Institute, between 2007 and 2012, governments in the U.S., Europe and the U.K. collectively benefited by $1.6 trillion, primarily through reduced debt service costs and increased profits remitted from central banks. Most of this wealth transfer came from households, pension plans, insurers, and foreign investors, mainly through lower interest earnings on savings. It is now time that businesses and governments focus on helping the real economy to solve large problems including debt, lack of growth, industrial stagnation, slowing innovation and productivity, aging demographics, income inequality, resource scarcity, and environmental threats. Financial engineering masks the true performance and health of companies and nations. But the damage goes much deeper, deluding decision makers into thinking that things are better than they are, and that solutions to build up problems can be deferred, or even solved painlessly.
Why are we so reluctant to accept that the future is outside our control? 
Eight years after the crisis of 2008 09, central banks are still injecting $200 billion a month into the global financial system to keep it from imploding. The returns on their "investment" is diminishing rapidly, and they're losing control of everything that matters.At the heart of modern macroeconomics is the illusion that uncertainty can defined by the mathematical manipulation of known probabilities, but to understand and weather booms and busts requires a different approach to the modern current economic model thinking about uncertainty. This truth is embodied in the first law of a financial crises that is an unsustainable position can continue for far longer than you would believe possible. What happened in 2008 illustrated the second law of financial crises: when an unsustainable position ends it happens faster than you could imagine. The lesson proved again and again is that no amount of sophisticated statistical analysis is a match for the historical experience that ‘stuff happens' very often at the wrong and most ill prepared time. As an investor, you’ve got to expect the unexpected.

It is an unfortunate reality that most people tend to be oblivious to massive sea changes in geopolitics and economics. You would think that these events would catch the immediate attention of everyone as they happen, but usually it is not until they realize that the microcosm of their personal lives is subject to the consequences of the macrocosm that they wake up and take notice. If you thought 2016 was weird, I suggest you get comfortable with the surreal because it is not going away anytime soon.

2017 offers a veritable treasure trove for the unexpected, off the unexpected.

Filed under:

This area of the site is for independent financial commentary. These blogs are provided by independent authors via a common carrier platform and do not represent the opinions of does not monitor, approve, endorse or exert editorial control over these articles and does not therefore accept responsibility for or make any warranties in connection with or recommend that you or any third party rely on such information. The information available at is for your general information and use and is not intended to address your particular requirements. In particular, the information does not constitute any form of advice or recommendation by and is not intended to be relied upon by users in making (or refraining from making) any investment decisions.


Comments are turned off for this article.

Site by Everywhen