Let’s face the harsh truth: the monetary techniques of central banks around the world have become ineffective. No matter what they do now, governments are already over-indebted and there is no easy solution. Yet with the crisis rapidly approaching, what can be done to mitigate its destructive effects and help salvage the economy after the crash? Writes Oliver Taylor.
Don’t buy into attempts to downplay the situation and make it look like they have it all under control: central banks and governments themselves are struggling to figure out what to do next! In fact, these institutions will not be able to mitigate the impact of the upcoming collapse the same way they did a decade ago. The overnight rates — the central banks’ main tool for influencing monetary policy, have already hit rock bottom and do not appear to have any success in stimulating growth any longer.
What’s happening in the European Union is perhaps the most obvious example of how this system has failed. Despite negative rates, the economies of the eurozone, especially its primary sources of income, are decelerating. Meanwhile, the response to these challenges has not quite been updated to meet the new realities. By continuing to promote negative interest rates, the European Central Bank might actually be doing more harm than good.
As it is right now, governments will have to intervene heavily with investments and other fiscal stimuli if the global economy continues to slow down. However, governments are already drowning in debt and their ability to act is limited. Just take a look at the national debt of some leaders in the world…The public debt of the United States is at an all-time high, sitting at $22 trillion USD! Japan’s national debt is $9.087 trillion USD - 234.18% of its GDP. Greece, Portugal, Italy, Belgium, Cyprus, Spain - all these countries rank in the top ten worst debts in terms of debt-to-GDP ratio.
Let us also not forget that central banks were critical in bringing upon the last economic crisis. They made it seem like we have recovered since 2008, but these last ten years were anything but a recovery - it was the period during which the central banks have used up all of their ammunition to create an illusion of stability and prosperity. And now, judging by the situation we have ended up in today, considering the upcoming collapse that will hit harder than most can possibly imagine, it becomes clear that there was no stability or prosperity to begin with. Now, they are running out of juice.
Frankly, it almost feels like bankers and governments no longer recognise and connect with the world around them. Having missed, or perhaps deliberately ignored all the red flags, they have become ill-prepared to help the markets in this upcoming recession. One of the truths they must face is that the economy will not return to any sort of normality before the next crash. The other, is that the trade wars between some of the world’s leading countries are actively undermining any possibility of remedying the situation.
OUT OF AMMUNITION
With regard to stability and prosperity, it is rather shocking to witness that central bankers still have not figured out how to manage inflation, even ten years after the last crisis. If they are already struggling to maintain some semblance of economic growth, imagine what will happen when the actual recession peaks? Mind you - when and not if, because it is unavoidable. Japan and Europe have already crossed a point of no return and the United States is well on the way toward the same fate.
To complicate matters even further, the world is no longer the same that central bankers knew and were used to, especially since the recent rise of populist governments. Not only do these movements fearlessly question the foundations of the economic orthodoxy in terms of free trade and respect for the rule of international law, but they sometimes defy even economic common sense.
Such is the case, for example, with the Federal Reserve not having a single clue on how to respond to the challenge of Donald Trump’s many trade wars, which damage the economy of the United States and the world as a whole. Considering that nowadays, the US only accounts for 15% of the global economy and 10% of its trade, it has become irrational to keep two-thirds of the bond market in US dollars. This is a drastic change that the greenback-dependent economy is not prepared for, but a change that is coming one way or another.
The unsettling, unreasonable importance of the US dollar in the global economy has been questioned before, but it didn’t appear to be quite as problematic back then, when the United States was still seen as the leader of the global economy. Now, with the undoing of the illusion created by unsustainable debt and a currency that has no intrinsic value, the failure of the American economy is becoming apparent and shattering the trust it used to enjoy. Meanwhile, central banks cannot manage to understand the new reality they have been plunged into and they no longer have sufficient ammunition to sustain the next crisis. That is the definition of being stuck between a rock and a hard place.
A CASE OF LIFE IMITATING ART?
On the one hand, if interest rates are raised, it will indubitably scare and alienate the market; on the other, launching another round of Quantitative Easing, will destabilise the situation even further, only hastening the inevitable. In a nutshell, the conventional monetary policy tools can no longer adequately respond to these new challenges. The predicament is somewhat similar to a scene from the 2007 action thriller feature Live Free or Die Hard, in which detective John McClane manages to down a helicopter by racing in a speeding automobile and ejecting from the car at the last minute, launching it through the air like a projectile at the aircraft, in sheer desperation. After this feat, his sidekick humorously quips:
“You just killed a helicopter with a car!” To which McClane replies: “I ran out of bullets.”
This is the predicament we have currently arrived at: with central banks that are out of bullets and that may very well need to do the impossible monetary equivalent of killing a helicopter with a car, in order to overcome the next great crisis. The keyword here of course, is impossible.
It is a shame that the financial community has only now began waking up to this problem. Central Banks have not rebuilt their stockpile of anti-crisis “bullets”. Then again, where would they have found the resources to restock? Thus, they are going into what may perhaps be the greatest recession the modern world will see, completely unprepared to deal with it. They have understood this a little too late. By the time the byproduct of irresponsible monetary policies hits the fan, countries will have too little room for manoeuvring in terms of what they can do to mitigate the damage.
A few years ago, this article may have read like an economist’s wild fantasy. Yet nowadays, many mainstream press outlets are writing about the prospects for the global economy in less than optimistic terms. So what happened? Why the sudden change of tone? Well, at some point, you can no longer continue to hide the pink elephant in the room and you must address the issue.
TURBULENT TIMES AHEAD?
Some argue that the next crisis has been underway since 2018 and it is getting more dangerous by the day. If you have been paying attention, you may have seen its many symptoms: economic slowdown, recession of global industry, declining activity in many countries and a strong deceleration of growth worldwide…The worst part, is that the institutions we would normally look to for help in rebooting the economic machine are all out of options themselves.
In fact, only the countries with significant foreign exchange reserves and/or significant fiscal space have enough to cope with this next crisis, and those countries are few — mainly China and Germany. Aside for Germany, the eurozone is ill-prepared: its refinancing rate is already at 0%, public debt is too high and printing new money has had, and will likely have very few positive effects on economic growth. In these conditions, the crisis of 2020 may be even more dire and destructive than that of 2008.
It all comes down to the fact that, in order to weather the storm of the next crisis and prevent further degradation, it is crucial to apply deep reforms to the economy at its core — even to the philosophy behind the way we treat finance. Meanwhile, investors, consumers, business owners and everyone else that will be affected by the recession, must realise that they can no longer count on institutions to hold their hand through the turbulent times ahead. EG