The Committee to Destroy the World. Lewitt Michael E.

Bond Rating Agency writes: “ZIRP [zero interest rate policy] has reduced the cost of funds for the $15 trillion asset U.S. banking system from roughly half a trillion dollars annually to less than $50 billion in 2014. This decrease in the interest expense for banks comes directly out of the pockets of savers and financial institutions.”14 In other words, banks are paying out hundreds of billions of dollars less in interest as a result of the Fed’s repressive policies. In fairness, this is not a one-way bet; consumers also pay lower mortgage rates. But ZIRP and QE have clearly benefited borrowers while punishing savers.

      While economists believed that interest rate repression would stimulate economic growth and reduce inflation, it did nothing of the sort. Instead, it suppressed economic growth and unleashed epic financial asset inflation while doing little to reduce inflation in goods and services. The latter only looks tepid because the government measures it in ways that have little to do with the real world. Fed apologists can use all the excuses in the world, but there is only one of two ways to explain this: rank incompetence or a willful desire to distort the facts.

      Negative interest rates in Europe are a symptom of policy failure and a violation of the laws of capitalism. The same is true of persistent near-zero rates in the United States and Japan. Invisible rates render it impossible for fiduciaries to generate positive returns for their clients, insurance companies to issue policies, and savers to entrust their money to banks.15 They are a symptom of failed economic policies, not some clever device to defeat deflation (which for the most part doesn’t yet exist or pose a serious threat) and stimulate economic growth. These policies are mathematically doomed to fail regardless of what economists, who are merely failed monetary philosophers practicing a soft science, purport to tell us. The fact that European and American central banks followed the path of Japan with virtually no objection represents one of the most profound intellectual failures in the history of modern economic policy.

      While the global economy is facing a solvency problem linked to excessive debt accumulation, the world’s central banks are pursuing policies designed for a liquidity problem. As noted above and discussed further below, the only solutions in this known universe for a solvency problem are inflation, currency devaluation or default (the other possibility, extremely high rates of growth, is unrealistic). Since none of these real-world solutions is politically palatable – no leader on today’s world stage has the courage to propose them and would be voted out of office by selfish and short-sighted constituents if he/she did – central banks are left creating huge doses of debt since equity can’t be conjured out of thin air. But all of this debt is just exacerbating the solvency problem and failing to solve the liquidity problem, pushing global markets closer to crisis.

Out-of-Control Global Debt

The global economy cannot generate enough income to service and/or repay the debts it has already incurred or, for that matter, the incalculable trillions of dollars of future promises politicians have made. In this respect, the United States is just a microcosm of the rest of the world. As Figure I.4 illustrates, debt has grown much faster than the economy in the United States since the early 1980s. Furthermore, the gap between the growth rate of debt and the growth rate of the economy has accelerated over the past two decades, which guarantees that the economy can never hope to catch up and generate enough income to pay the interest or the principal on the debt.

Figure I.4 Debt Has Grown Much Faster Than the Economy in the U.S. Economy

      SOURCE: BofA Merrill Lynch Global Investment Strategy, Federal Reserve Bank, DataStream.

      In September 2014, the Geneva-based International Centre for Monetary and Banking Studies published a study entitled “Deleveraging? What Deleveraging?” where it reported that, “[c]ontrary to widely held beliefs, the world has not yet begun to delever and the global debt-to-GDP is still growing, breaking new highs.”16 The report was written by the highly respected economists Vincent Reinhart of Morgan Stanley, Lucrezia Reichlin of the London School of Business, Luigi Buttiglione of Brevan Howard Capital Management LP, and Philip Lane of Trinity College in Dublin. Going further, the report’s distinguished authors warned that, “in a poisonous combination, world growth and inflation are also lower than previously expected, also – though not only – as a legacy of the past crisis.”17

The authors showed that, excluding the leverage of financial companies worldwide, debt was equivalent to 212 percent of global GDP, up 38 percent since 2008. Debt was equivalent to roughly 264 percent of GDP in the U.S., 257 percent in Europe, and 411 percent in Japan. While debt was rising, global growth was falling. The six-year moving average of the world’s potential growth rate fell to below 3 percent post-crisis from about 4.5 percent before the crisis, no doubt largely due to the much higher level of debt weighing on economies. When increasing amounts of financial and intellectual capital are devoted to servicing debt, growth is bound to suffer (see Figure I.5). Further, the authors point out: “Deleveraging and slower nominal growth are in many cases interacting in a vicious loop, with the latter making the deleveraging process harder and the former exacerbating the economic slowdown. Moreover, the global capacity to take on debt has been reduced through the combination of slower expansion in real output and lower inflation.”18

Figure I.5 Global Debt Has Increased by $57 Trillion since 2007, Outpacing World GDP Growth

      SOURCE: Haver Analytics, national sources, World Economic Outlook, IMF; BIS; McKinsey Global Institute analysis.

      This disturbing picture was confirmed several months later by The McKinsey Global Institute. In a report entitled “Debt and (Not Much) Deleveraging,” McKinsey reported that between 2007 and 2014, global debt had grown by $57 trillion to $199 trillion, raising the ratio of global debt-to-GDP by 17 percentage points. Developing countries have accounted for half of this growth; government debt has soared (by $25 trillion) and private sector deleveraging has been limited. Households in the U.S., UK, Spain, and Ireland had deleveraged somewhat, but elsewhere they had not. In particular, as noted earlier, China’s total debt quadrupled from $7 trillion in 2007 to $28 trillion by mid-2014, fueled by real estate and shadow banking, and China’s total debt as a percentage of GDP exceeded that of the United States (but honestly, who knows how bad China’s opaque debt figures really are?). McKinsey summed up the last five years of the global economy: “[i]t is clear that deleveraging is rare and that the solutions are in short supply.”19 Actually, it is not solutions that are in short supply but rather the political and moral courage to implement them.

      Both the McKinsey and the Geneva reports illustrate beyond a shadow of a doubt the unsustainable and dangerous path on which the global economy is set. Even worse, the policy mechanisms that brought the world to this point largely destroyed the market’s ability to send meaningful pricing signals to market participants. Since the crisis, central banks have been the largest buyers of government bonds, distorting the market’s normal supply/demand dynamics and “snapping the antenna” off the bond market in the words of economist Dr. Philippa Malmgren.20 Governments have distorted the price of benchmark bonds as well as the price of money and made it virtually impossible to determine the natural rate of interest or inflation.

Untamed Derivatives

      One of the primary forms that global debt has assumed in the modern economy is the derivatives contract. AIG blew up because it wrote too many derivatives contracts on collateralized bond obligations that held billions of dollars of subprime mortgages. But the derivatives threat in the market in 2008 was much broader

14

Christopher Whalen, “Central Banks, Credit Expansion, and the Importance of Being Impatient,” Kroll Bond Rating Agency, March 20, 2015.

15

In Europe, there is an even bigger risk in entrusting one’s money to banks. As the citizens of Cyprus learned, their savings can be confiscated by the government. This calls into question the integrity of the banking and the financial system and the very tenets on which society is organized and is almost certain to lead to social unrest and violence.

17

Ibid., 2.

20

Dr. Philippa Malmgren, Signals: The Breakdown of the Social Contract and the Rise of Geopolitics (London: Grosvenor House Publishing Limited, 2015), 325.