Interest rates have been zero for 90 months.
This is not normal. Something fundamental has changed.
It’s fascinating how rarely we discuss the root cause of zero interest rates.
David Stockman is one of the financial commentators I occasionally read because he has a good understanding of the widespread and un-prosecuted fraud that took place leading up to the 2008 crisis, and because he understands the dangers of excessive debt.
Today Stockman wrote an article on zero interest rates.
The Cult of Central Banking is Dead in the Water
Stockman understands something is seriously wrong…
There has never been a time in financial history when anything close to this happened, including the 1930s. Nor was interest-free money for eight years running ever even imagined in the entire history of monetary thought.
He understands that the symptom is insufficient growth and that more cash and credit won’t cure it…
There is a structural growth problem, of course. But it has absolutely nothing to do with monetary policy; and it can’t be fixed with cheap money and more debt, anyway.
He understands that the medicine we’ve taken is not working…
Since the year 2000 when monetary repression began in earnest, the balance sheet of the Fed has risen by 800%, while the amount of labor hours used in the US economy has increased by 2%.
At a ratio of 400:1 you can’t even try to argue the counterfactual. That is, there is no amount of money printing that could have ameliorated the “no growth” economy symbolized by flat-lining labor hours.
He understands that our response has been fraudulent, at least in an ethical sense, for future generations…
In essence, during the last 15 years the Fed has gifted the US economy with a $4 trillion free lunch. Uncle Sam bought $4 trillion worth of weapons, highways, government salaries and contractual services but did not pay for them by extracting an equal amount of financing from taxes or tapping the private savings pool, and thereby “crowding out” other investments.
He understands that zero interest rates are no longer helping household incomes because the private sector reached Peak Debt in 2007 and is now slowly reducing its debt…
He understands that cheap credit has created new problems waiting to explode…
Likewise, total US business borrowings have increased from $11 trillion to $13 trillion since the fall of 2007, but it has not lead to additional investment spending. Instead, the Fed fueled inflation of financial assets has induced businesses to cycle virtually 100% of their incremental borrowings into financial engineering. That is, stock repurchases and M&A deals.
Indeed, as we demonstrated in a post earlier this week—–precisely 100% of the entire increase in corporate borrowing since the turn of the century has been pumped back into the casino in the form of stock repurchases.
The world is drowning in excess production capacity owing to the massive worldwide credit inflation and repression of capital costs during the last two decades. That was the effect of total global credit growth from $40 trillion in the mid-1990s to upwards of $225 trillion today—-an $185 trillion expansion that exceeded the growth of global GDP by nearly 4X during the same period.
So far so good, then we get to Stockman’s diagnosis and prescription…
In fact, tepid growth of labor hours, productivity and output is a supply side problem. In that respect, replacing the current burdensome 16% payroll tax on America’s high cost labor with a consumption tax on the nation’s heavily imported goods would do more for supply side growth than central bankers could ever accomplish in a month of Sundays.
In a word it is this. Fire the Fed. Attend to supply side policy. Let market capitalism do the rest.
Stockman’s diagnosis is that growth is stalled because US labor costs are not competitive. His solution is to stimulate growth by shifting taxation from payroll to import duties.
His logic is obviously flawed. If uncompetitive labor costs are the cause of low growth, why is the entire world struggling to grow?
Stockman believes productivity originates from…
… work, exertion, sweat, discipline, enterprise, innovation, invention, sacrifice and savings.
He completely misses the vital role of energy in our economy.
Here is what is actually going on…
A growing economy means that total income is increasing. Income equals productivity (what is produced) plus the change in debt.
Productivity results from combining effort (labor), capital (machines and credit), knowledge (technology), raw materials (stuff), and energy (90+% non-renewable fossil) in an efficient manner (efficiency).
We have no shortage of labor (plenty of unemployed), no shortage of capital (plenty of idle machines and low-cost credit), no shortage of knowledge (plenty of new graduates), and no shortage of raw materials (yet). Our efficiency is pretty good and is approaching engineering limits for improvement.
Our productivity growth has stalled because our energy use growth has stalled because the cost of extracting fossil energy now exceeds what we can afford to pay while growing.
The cost of extracting fossil energy has been increasing at a compounded rate of about 17% per year because it is a finite resource and we chose for obvious reasons to burn the easy to get and inexpensive energy first. What remains is expensive and will get progressively more expensive to extract.
The trick we have used since about 1980 to hide this inconvenient energy reality is to increase our debt faster than our productivity.
When we borrow more money than we repay in a given year, the difference (credit) looks and behaves like earned income (productivity). It makes no difference to our lifestyle if we pay with a $20 bill or our MasterCard.
Eventually we reach a limit to the amount of debt we can service with our income. This limit can be extended by reducing interest rates, which we’ve done, but even at extremely low rates there is still a maximum amount of debt that can be supported by a given income.
Citizens reached their debt limit in 2007 which precipitated the 2008 crisis.
Since 2008 we have been masking our energy reality by increasing public debt which, unlike private debt, is not limited in the short-term by income because governments can print money to service their debt.
There are several ways to print money. The method we have used so far is called quantitative easing (QE) which is the government borrowing money from itself and us winking at each other and telling ourselves that we intend to repay the debt someday. Any honest assessment of our ability to repay our government debt from taxes would show that the debt cannot and will not be repaid.
Another type of money printing, which we may soon try, is to print and hand out money directly to citizens. The main difference from QE is that we will stop winking at each other.
The implication of printing money is that we have chosen to reduce the value of future money to maintain our current lifestyle. Put another way, we are living beyond our means and the difference between what we are spending and what we are earning will be subtracted from our future standard of living. This means we are making the future much worse than it needs to be.
The thing that’s sustaining our standard of living (public debt) is growing faster than the thing needed to sustain the public debt (our productivity). This is one definition of a bubble.
We are living in a giant, global, and unprecedented debt bubble.
All bubbles, by definition, must burst.
When bubbles burst they always revert through their mean. The bigger the bubble, the greater the unnecessary future pain we create.
When bubbles burst they never deflate slowing in a controlled manner. We will not experience a smooth transition from our current standard of living to a new lower standard of living. It will be a bumpy and probably unfair process where those least deserving of pain are hit the hardest.
When our bubble bursts it will create real hardship with little or no time to adjust, and will create the conditions necessary for social unrest, crime, despots, and war. The worst of history will likely repeat but on a much larger scale because our situation is unprecedented.
The relationship between the economy and energy is clear yet even the better commentators, like Stockman, are in denial and choose not to look.
Growth is over. De-growth is coming soon.
Most will say “no one could have seen this coming”.
The facts are clear for anyone that chooses to look.
We could have reduced our population and lifestyles in a safe, civil, and fair manner, with the added benefit of less damage to the environment, which we’ll desperately need when the oil is gone, but chose not to because of evolved denial.