Wednesday, October 28, 2015

Complacency In The Face Of A Slowing Economy

At Some Point It Gets To Hot!
It is time to revisit the issue of complacency and whether we have been lulled into such a state by the extraordinary actions central banks and governments have taken since 2008. This is a key question facing all of us as we again hear cries that Central Banks should embark on a new round of monetary easing. This brings forth some very serious issues concerning how we now tackle an economy where growth is again clearly slowing. Low interest rates have punished savers, distorted markets, and caused capital to be allocated in nonproductive ways. By not demanding the right kind of growth and simply throwing money at problems we have only delayed and are adding to a much larger crisis lurking in the future. 

In our fast moving world many people have come to think if a financial crisis doesn't occur today or in the next few weeks it is simply not going to happen at all. Over the years I have penned several articles claiming that America had been lulled with the rest of the world into merely kicking the can down the road. Each day that passes without the arrival of a massive economic Armageddon only reinforces the idea that far too much has been made as to the ramifications of growing debt in America and throughout the world. Looking back at the horror stories surrounding sequestration and the financial cliff I recall how on one Sunday morning talk-show the host referred to the proposed spending cuts as draconian and predicted dire consequences. Just days ago a budget was endorsed that rolls back many of these cuts, so far the message is that sidestepping financial responsibility has been rather painless and this only reinforces the idea that we can continue down this path.

The much loved theory that we will be able to grow our way out of our difficulties and muddle through is a bit simplistic and much overused. This strategy is often viewed as a painless easy solution to problems because growth has a way of obscuring hard to address deeper rooted structural flaws that undermine our economic system. Many people forget we are living in very unusual times and that no historic parallels exist to guide us forward. Hoping that after some type of economic setback the worst is largely behind us is a poor strategy to embrace in confronting the challenges of tomorrow. A feeling that we have rounded the corner and the promise of better days ahead have a way of easily overtaking us and much of this optimism is rooted in the faith people have in Modern Monetary Theory, which is often referred to as MMT.

MMT also known as neochartalism is a economic theory that details the procedures and consequences of using government-issued tokens and our current units of fiat money.  Newly acquired tools like derivatives and currency swaps  allow us to print and  manipulate away problems. MMT promotes debt. While reading an article about the growth of debt in China's non-financial sector I was forced to reflect on how debt is encouraged to grow in a MMT system. Currently China is the poster-child of how easy money distorts growth and ushers demand forward. In Europe the ECB had to step in to halt the economic collapse of Spain, Italy and several other debt laden countries that were on the brink of economic collapse. MMT allows those making the rules to break the ties between debt and interest by manipulating away prior standards.

This has added a whole new dimension to economics that seeks to eliminate the potential of failure and economic collapse. However, there is a central  flaw in the concept  of MMT that will prove to be its Achilles heel, and that is as more money is poured into the system lower interest rates at some point are no longer effective in driving the economy forward. As the extra GDP growth generated by each batch of loans drops and momentum ends MMT becomes the equivalent of pushing on a string. When the economic efficiency of credit collapses many of the central bank's options quickly evaporate. Artificially low FED controlled interest rates are a massive "one-off" or onetime tailwind that should be considered mainly behind us and are destined to bring diminishing returns. The "almost surreal" feeling of indifference towards reality that has developed as to the limits of what central banks can do is very troubling.

The fact is companies have already ushered all the savings from interest paid on debt into the earning column and a major reason inflation remains low is that money has flowed into paper assets instead of tangibles. Many companies are sitting on a hoard of cash, this has lowered the velocity of money, others exist on a mountain of debt. A strong shift could develop at any time and disturb this unnatural balance. When rates stop going lower or reverse the positive effect garnered from these policies will ebb and become a major headwind. With massive government debt in many countries and our economy still weak this headwind has the potential to become devastating. The collision of MMT, social unrest over inequality, and other destabilizing factors have the potential to create the perfect storm that will remind the world that dept does matters.


  1. Many parts of the world economy are already in a recession and they are slowly pulling the other parts underwater. Central banks have used up most of their resources on the last recession and don't have much left to combat the new one. It is a matter of when.

  2. The jig is almost up. As soon as the man on the street realizes our money is just paper and a bank account is untouchable, the dollar will collapse.