by Mitch Feierstein about 10 years 2 weeks ago
Last week, the Bank of England declared its intention to print another £50 billion. Hardly anyone noticed. That £50 billion will bring the Bank’s total money printing to around £425 billion, or about one quarter of British GDP. No one cares. This evening, the U.S. Federal Reserve will announce its own plans for another round of “quantitative easing” aka QE infinity — a euphemistic term for “destroying the currency.” Not to be left out, the ECB has announced plans for unlimited bond buying (though Germany has, thank goodness, set some limits.) Given that the bonds the ECB wants to buy are issued by increasingly bankrupt Mediterranean governments, the ECB too is doing what it can to wreck the currency it’s charged to protect.
Given such public sector diligence, it’s hardly surprising that the private sector is getting creative all over again. And while creativity is normally thought of as a good thing, the same ingenuity in the hands of Wall Street is always a disaster. Take one recent news story. New rules, due to come in place next year, will force derivatives-traders to post collateral for their risky bets. Proper collateral. You know: U.S. Treasury bonds and the like, stuff you can rely on. Trouble is, the derivatives market is huge and good quality collateral is scarce. (Which is a good outcome, right? It would mean that only the most necessary derivatives trades get done.)
Only that’s not how Wall Street sees these things. When they see the phrase “good quality collateral,” they instantly think, ‘how can we fake things so that crappy collateral manages to sneak through anyway?” And, what do you know, they’ve come up with a solution called collateral transformation. That solution is twisted enough that I won’t even describe it here — but suffice to say that it’s like the subprime markets all over again. It’s worse than that, actually, because at least with subprime there was a house at the end of the chain. Here, there’s dodgy collateral supporting a derivatives trade backed by a financial security backed by something else altogether. It’s subprime squared or subprime cubed.
But enough of all that. The Bank of England (and the Fed and the ECB) are all thrilled to the bottom of their inflation-creating hearts because the financial markets are boosted by all these interventions. The German stock market index, the DAX, is up 46 percent in the past twelve months and has almost doubled from its 2009 lows. Doubled. Would you like to write down on a sheet of paper all the good things that have happened to the German economy since 2009? If you do, you can use a very small sheet and still have room for plenty of doodles. The simple fact is that these financial market interventions have almost nothing to do with the real economy.
That same basic point is obvious in a million different ways. The London property market is hitting new heights — just when the British economy is spluttering to get out of its double-dip recession. The FTSE index is romping away — but George Osborne is hastily rewriting his budget projections as corporate tax revenues fall far short of what was expected. In the U.S., Apple, Inc. is hitting new extraordinary heights, even as the latest U.S. jobless figures show that people are quitting the labor force on a historically unprecedented scale.
That’s not to say that monetary expansion has no effect, just that the effects are almost entirely destructive. So property inflation is bad (that’s part of what got us into this mess), but it’s one of the most obvious symptoms of Mervyn King’s policies. Bubbliness in the financial markets is also terrible (that’s the other major part of what caused this mess), yet there they are once again, bubbling away, utterly disconnected from the brutal truth of the real economy. And of course as the major currencies fight each other in a race to the bottom, the commodities produced by the rest of the world, with their strengthening currencies, becomes more expensive too. Inflation starts to get baked in.
Inflation, and also indebtedness. The ECB wants to protect Europe by buying up ever larger chunks of poor-quality debt. But who are they kidding? Next year, Spain and Italy alone have to refinance more than €600 billion. The same again, give or take, the year after. And those numbers are as nothing compared with the amounts of private sector (mostly financial) debt that has to be refinanced. A trillion euros next year, €1.2 trillion the year after. These numbers can’t be rolled over by more smoke-and-mirrors. They can only be funded by sound public finance and strong private sector business growth. Needless to say, we don’t have either.
In truth, the lessons aren’t difficult to see. We need sound money and an end to financial engineering. If the rules say that derivatives trades need sound collateral, then any scheme which looks to evade those rules needs to get kicked into touch. (Or more. Rules need to be enforced or there’s no point in having them. In a sane world, the banks and bankers currently busy on ‘collateral transformation’ need to be stopped and held accountable.) Central banks need to forget about the ‘health’ of the financial markets altogether. It’s not their health that matters, it’s ours.
People will say — correctly — that coming off these drugs will produce one hell of a withdrawal period. That’s true, but it’s not a reason to keep someone on heroin. Quite the opposite. The Western world needs to relearn some simple lessons. If you make a bad loan, you’ll lose money. (You won’t get rescued by the taxpayer.) Investment banks are there to deliver useful services to real companies. (Anything else is yet another Ponzi scheme, and probably fraud.) Businesses will succeed by making and marketing fantastic products at competitive prices. (Financial engineering is meaningless and will always destroy value in the end.)
These lessons are obvious, but our policy-makers don’t hear them. Maybe George Osborne does to some extent, and Vince Cable too. But they’re swimming against a tide of denial. That tide is running as high as the global equities and fixed income markets. One day soon, the tide will drown us.