During the last 40 years, central banks have gained power they previously could only fantasize about. They were given full control over the currency supply and interest rates. These are the tools to plan booms and depressions. Thanks to such a great authority banks could create economic bubbles and their inevitable bursts. The result is one of the biggest capital migration in history from the middle class to 1% advantaged with access to particular data in advance.
Remnants of the gold standard limited bankers until 1971 but for 40 years they enjoyed free reign with no government nor society being able to meaningfully control them. You must have heard this line that a central bank "has to be fully independent" – by default, it has to be independent from the society.
The last link to the gold standard fell in 1971 and since investment banks and central banks have enjoyed an ever-growing influence. Careless actions and privileged position led to a drastic jump in risk and the first serious crisis in 1998. The first domino to fall was the bankruptcy of Long-Term Capital Management - an investment fund managed by two Nobel Prize winners. Instead of letting this institution fail, lobbyists pushed the government to save it. The message for senior executives on Wall Street was clear. It does not matter how big the risk is, someone will have to save us. At the end of the day, we are too important to be left behind.
As a natural consequence. crises in 2001 and 2007 followed previously laid scenario. The government saved bankrupted entities with taxpayer’s money while central banks lowered interest rates and showered capital markets with additional funds to gamble with. The reason behind the crisis became the bitter cure for financial disasters.
Every single time the economy was down, the danger drastically snowballed. After 2007 slump we saw a coordinated action of central banks aimed at lowering interest rates and printing additional currency at a scale unseen before. The difference between this meltdown and the previous one was that central banks were given free hand to battle the results of their own wrongdoing.
Before 2008 central banks’ responsibility was to deliver the capital to commercial banks. During the last crisis, respective governments took it upon themselves (or rather taxpayer’s back) to take over toxic assets and increased indebtedness to ‘stimulate’ the economy. To learn from other’s mistake it was sufficient to look at Japan’s case to understand how big of a failure this approach is. People learn only during crises and not proactively thus we see Abenomics spread all over the world.
To finance ballooning government spending regime can either increase taxes or increase debt. The government chose the latter.
Investors understood how bad economic situation was in the majority of countries. Everyone is prudent about the money they worked hard for and this is why investors were not keen to borrow to authorities through bond purchases. Under normal conditions, the worse situation of a borrower the higher the interest rate is to compensate for the higher risk of bankruptcy. This market mechanism limits the state ability to borrow money and also indirectly prevents from bankruptcy.
Understanding the gravity of this situation central banks entered this casino. If bankrupted governments cannot acquire the capital cheaply it is up to us – bankers – to print currency and borrow authorities as much as they need. These practices called ‘monetisation of debt’ were linked only to the 3rd world countries before and always ended up with a spiral of hyperinflation and a total loss of currency credibility.
This time, central banks under the umbrella of the Bank for International Settlements (BIS) figured out a truly devilish idea. A destruction of one currency is visible but a destruction of every currency at a similar rate will preclude panic in the financial market when investors would start pulling their money out.
The first one to start printing was the FED. Six months later the BOE joined and the ECB began printing only in 2011. In the same year, we saw storm clouds gathering over the PIGS debt. After famous Draghi’s “whatever it takes” line, Germany gave a green light to destroy Eurozone currency to save both German and French banks filled with bad debt of Southerners.
Below you can find a chart (far from perfectly) showing how central banks continued the printing relay to save the system they are the biggest beneficiaries of.
The bill for the last 12 months of central banks’ buying spree is 2.5 trillion USD. Financed by nothing else but printing machines.
This is official data but it may as well be that facts are more dreadful. The FED officially stopped their purchase program of the US treasuries at the end of 2014. When we analyse what is happening today in the financial market it is clear that the truth is different.
According to the official record, the FED has not bought any government debt for 2 years. Other central banks also keep selling the debt as you can see on the chart below. Simultaneously the US government increased its debt by almost 3 trillion USD. Interestingly, the yield of the US debt fell from 2.4% to 1.7%.
To summarise, the world is dumping American debt, the US continues to issue fresh 1 trillion every year. How is that possible that the price goes up?
The answer: there is a buyer on the market purchasing a vast amount of UST sold by everyone else. This anonymous buyer may be the Exchange Stabilization Fund as they do not need to report to anyone. Who gave them 4 trillion USD to buy this debt? Most probably the FED which is above all the law too – proven by 2010 Congress testimonies. This is when we heard that 16 trillion USD was printed out of thin air and borrowed to banks in the US and Europe. We should remember that even Ben Bernanke “did not know” who got this money. He also did not see any problems in FED printing the amount of the US GDP.
This is why we can assume that the speed of currency printing is not 200 billion USD but rather 350 – 400 billion USD each month!!!
In case you think the estimate above sounds like a conspiracy theory and we should only use official data, I encourage you to pay attention to who owns most assets bought during QE. It looks clearly that the 4 biggest central banks – FED, ECV, BOJ, PBOC – own 75% of all central banks' assets in the world.
If one can influence the central bank’s policy - and the BIS has this sort of control - one has to coordinate only 4 institutions to destroy the purchasing power of currencies in a controlled manner through currency and asset price manipulations.
You could have read many times on this blog that we ‘enjoy’ high prices of equities thanks to (among others) the huge and continuous QE program. Despite official position of the FED (not printing) equity prices in the US are very high. How is that possible? The Federal Reserve does not need to officially buy equities to push their prices up. Another central bank can do this for the FED, also indirectly.
Think about the following scenario. The BOJ buys equities in Tokio. The central bank is a buyer whereas other party sells them. This selling party now has money to buy equities in places like Europe or the US. For example, the Swiss National Bank spends a lot of money on buying equities of the biggest American corporations listed on NYSE. The BOJ owns 60% of all ETFs listed on Tokyo’s stock exchange.
The size of intervention i.e. central banks’ purchase program, is presented very well below. Balances of both FED and BOE are record high. Both banks were required to secure monetary stabilisation as their primary duty. Neither succeeded. Now they resemble hedge funds with infinite resources rather than institutions working for society’s good.
Dramatic increase in debt
Most of the interventions – buying government debt – cause an increase in public debt. At the end of 2007 average government indebtedness in the developed world was equal to 69%. Seven years later it was 104%. Today we expect 110-115% and what is worse, with only a few exceptions, there seems to be no end to governments' borrowing. A gigantic part of this debt is accumulated by central banks. At some point, they will become the biggest creditor of ‘independent states’. When kicking the can down the road finally disappears from the options’ list, authorities will receive an offer to write-off their huge obligations. The question is what kind of compromise will they accept (how much sovereignty will we lose)?
Central banks became the hostage of their own actions. Artificially suppressing interest rates for the last 8 years and constant currency printing made them lose all ammunition they were so happy to use during every crisis in the past. To prevent countries from going bankrupt, central banks only led to the explosion of the public debt.
A reasonable solution for today is for bankers to cause double-digit inflation with interest rates being low. This can reduce the amount of debt to manageable levels. The level of interdependency and risk is so high in the financial sector that no one can predict, not to mention control every aspect of how this state of affairs can develop.
A good example is rising LIBOR and very low liquidity. Can magicians from Basel handle this case or will stock prices in developed economies and bonds all over the world fall hard and violent to reasonable levels?