Does the ‘recovery’ matter?

I was thinking of starting this blog with a cynical comment along the lines of, “last week equity markets came off, I think we need another €1 trillion from the ECB!” – Okay, maybe it wasn’t the greatest joke but you get the idea. But then the Wall Street Journal beat me to it, and they weren’t even trying to be funny. In an article on weaker data in the Euro Zone one could find this remark:

The unexpected drop in the purchasing managers’ index survey suggests more stimulus from the European Central Bank through interest-rate cuts or additional bank lending may be required to protect the economy from a more severe downturn.

Sure. And why not?

Over the past 12 months the ECB expanded its balance sheet by 54 percent. At around 30 percent of GDP that balance sheet is now the biggest among the major central banks. The ECB’s printing press is providing an ‘unlimited’ backstop for all those financial ‘assets’ that nobody in their right mind would buy with their own savings, and providing ‘unlimited’ funding for the European banks, which are now permanently in intensive care. And we have to admit the strategy is not without success: Your neighbourhood Greek bank is again a going concern and those Spanish governments bonds are once more highly sought-after investments, even at single-digit yields. So, why not print another €1 trillion to get the economy really going? Isn’t it time the ECB really put its back into this whole stimulus business?

What a great policy ‘stimulus’ was back in 2001 when the Fed also ‘protected the economy from a more severe downturn’ and kept rates at 1 percent and blew the biggest housing bubble ever and thus set the world up for an even bigger ‘downturn’ in 2007. If you think about it, all our present problems are the result of past ‘stimulus’ – of past efforts to keep interest rates low and to ‘stimulate’ borrowing and encourage leverage. Now the interventionists of every couleur tell us that we can only get out of this mess by depressing interest rates even further for even longer.

Einstein said that the definition of stupidity was to do the same thing over and over again and expect a different outcome. This makes me wonder if economic intelligence has already been a victim of this unfolding crisis.

Exit the exit strategy

That may well be so. Last week I read somewhere that a hard-left candidate in France (not Hollande, someone even further to the left than him) demands that the ECB lend money directly to companies. I think that this idea is not that farfetched considering how quickly and easily today’s consensus has embraced extreme policy intervention. Only five years ago it would have been unthinkable that the world’s major central banks would become the biggest marginal buyers and single largest holders of their countries’ sovereign debt, or that they would offer unlimited free loans to their banks with multiple-year maturities against the dodgiest of collateral. These used to be the type of irresponsible things that responsible central bankers scoffed at. Today, this is standard practice in most of the highly industrialized world. What was crazy five years ago is now merely ‘unconventional’.

And this evolution should not come as a surprise. As I explained in Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown, what we are seeing is indeed the logic of the state fiat money system taken to its natural conclusion. The raison d’etre of the system was to not leave the setting of interest rates and the availability of credit to the free market. On a free market the level of interest rates and the availability of credit are naturally determined by the available pool of voluntary savings. The idea was always to massage interest rates to lower levels and to encourage additional money and credit creation. In a paper money system like ours, the banks’ ability to create deposit money and loans is largely the result of administrative decisions by the central bank – at least until the banks have OD’ed on cheap money and the central bank has to use its own balance sheet to keep credit growth going. This is where we are now.

As is true of all types of market intervention, once you fix one variable you have to fix others, and sooner or later you have to get involved in everything. As ever more sections of the economy become addicted to cheap money, the risk of higher yields and wider risk premiums becomes an ever more potent threat to the overbuilt house-of-cards. To avoid collapse, the central bank has to manipulate ever more asset prices directly.

The communist chap from France has simply anticipated the next step in the degradation of our paper money economy, the point where not only the government and the banks will be supported directly by the central bank but also the corporations and the consumer. What is good for the former certainly must be good for the latter. Why do Greek restaurants still face the risk of bankruptcy when Greek banks get limitless cash?

In any case, this development is much more probable than any kind of ‘exit strategy’ for the central banks. — You don’t hear about those exit strategies any more, do you? There is a reason for it. There are none. Every day that the present free-money-madness continues, the central banks are digging themselves a deeper hole. With ever more assets mispriced on cheap cash and with ever more balance sheets propped up by free loans, policy tightening is equivalent to pulling the rug from under the whole system. There is no way out.

On steroids

But back to the title of this Schlichter file. What recovery am I talking about? In Europe there apparently is none. But data has been improving lately in the United States, if at a snail’s pace. The ‘interventionists’ assign a lot of importance to these developments. Being interventionists, they pay little attention to the reasons for why we were in a recession in the first place. There is never much focus on the root causes of the crisis or any debate about if those have been removed. Recessions just seem to happen, so do asset bubbles and excessive leverage. All that matters is that the government creates some growth, then, with a bit of luck, this growth may just lead to more growth, and sooner or later we may just grow ourselves out of this mess. Simples.

I think the chances of that happening are pretty close to zero. And I do not care much about what present data is supposed to tell us. It does not make much of a difference.

Take the drop in official US unemployment. Could it be attributed to a decline in labour market participation as many long-term unemployed – their numbers have been growing markedly in this recession – drop out of the official labour market altogether? Or, could it be the result of the mild weather recently? Or, as the optimists will say, is it the result of additional hiring? Frankly, I don’t know and I don’t think it matters much.

We know what the problems have been and still are: misallocated capital and misdirected economic activity on a gigantic scale as a result decades of artificially cheap money. The policies of the interventionists – first and foremost zero interest rates and quantitative easing – were aimed at sustaining these imbalances, sabotaging their liquidation, discouraging deleveraging and postponing the – admittedly painful – cleansing of the economy of the accumulated dislocations. This policy has to a large degree succeeded, maybe with the exception of parts of the US housing market, which has indeed been correcting from bubble-levels. Other than that, I believe policy has so far managed to sustain the unsustainable a bit longer and thus project a false image of stability. Congratulations.

Of course, we can never exclude that this policy may also generate some additional activity here and there. Super-cheap money may not only stop the much needed deleveraging and cleansing but it may even encourage additional borrowing and additional investment. Who is to say that the trillions of new currency units will not cause some more balance sheets to get extended a bit further?

Fact is that none of what we see right now can be taken at face value. Not the equity rally, not yield levels, not headline economic data. Everything has to be taken with a sizable pinch of salt given the distortions from an outright surreal monetary policy stance.

But we can be sure about one thing: None of this should be taken as an indication of improving health. The patient is still sick but made to run laps around the track with the help of steroids, amphetamines and massive amounts of caffeine. The economy will not get fundamentally better until the underlying imbalances have been addressed and that is only possible if money printing stops and the market is again allowed to set interest rates and other prices.

I am not sure if the mainstream economists do really take a lot of encouragement from the manufactured asset price rally and the occasional green shoots in an economy that remains freakishly unbalanced and fundamentally sick. I don’t know what the economic data will tell us over coming months or quarters. I am confident that we are far from closing the book on the present depression.

In the meantime, the debasement of paper money continues.


  • Paul Danon says:

    Excellent (and worrying) as ever. Is anyone in politics listening? I’m not sure if the otherwise very sensible Mr Redwood is.

  • Paul Marks says:

    Mr Redwood is not (he has not, yet, freed himself from monetary expansion thinking – although more of the Fisher type than the Keynes type. However, a few members of Parliament have – and actually listen to what people like Detlev S. have to say.

    Sadly Detlev’s article starts with a terrible truth – the Wall Street Journal is mostly staffed by the same university conformists that the rest of the msm are made up of.

    The editorial pages may have doubts about “fiscal stimulus”, but the ordinary news pages and “monetary stimulus”? The School of Journalism …… who write those pages have no doubts (or much of anything else) in their heads.

    “What is to be done?” (to steal a line from a Russian aristocrat with demented collectivist ideas).

    I have not got a clue what to do.

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