GLOBAL DEBT series: PART II
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GLOBAL DEBT, PART II: Zombie Economy
by G. C. Seifrit
In the first of our three-part series, we looked at the truth (reality) of our global debt problem.
In Part 2, “Zombie Economy,” we focus on the economy and what we perceive to be the immediate and long-term consequences of policies and programs being used to deal with the problem.
Zombie Economy
The Euro area is in recession. By most definitions, Southern Europe is in depression.
The Financial Crisis left the world and global economy facing a new reality. The Crisis forced us to deal with the ramifications (consequences) of decades of profligate spending and indiscriminate debt financing – or quite simply, ‘living beyond our means.’
Today the world sits on a credit bill in excess of $200 trillion, an amount equal to 330% of total global GDP (income); and it continues to grow. This unmanageable pile of debt is a global problem, affecting virtually all the world’s developed economies.
An easy or straightforward ‘solution’ remains elusive (impossible). As we discussed in “It’s the debt, stupid!” (Part I), central bank monetary policies meant to resolve the debt issues – or at the least forestall imminent disaster – are only aggravating the problem. More importantly, they are putting a death nail into the global economy and prospects for substantive future growth, which ironically are the primary hopes for escaping an increasingly negative downward spiral.
Contrary to the talking points of central bankers and the body politic, the global economy remains weak. This is due in large part to central bank policies intended to help.
The rapid-fire, coordinated monetary intervention that helped stave off near certain systematic disaster in the 2008/09 Financial Crisis has now become an endless series of convoluted programs and ‘arrangements’ to maintain the system and manage the periodic mini-crises that continue to flare up. Though central banks appear to have succeeded in their immediate short-term goals, their ‘easy money’ policies are simply not working to promote constructive results for anemic economies.
Two-thirds of the world economy limps along with minimal signs of real recovery. There is sparse evidence of sustainable economic growth and meaningful future expansion. As we see it, the monetary programs and cheap money policies meant to address the debt, and heal and rehabilitate economic activity, are in reality now having quite opposite effects.
Virtual-zero interest rate policies and non-ending monetary easing (money printing) have not resolved the debt problem, and they have created an environment that curtails important real economic growth. The ‘easy money’ policies of global central banks are now producing negative returns.
We are creating a “Zombie Economy.”
‘Easy money’ is failing
In theory, the ‘easy money’ created by low interest rates and aggressive monetary easing should help the economy. It seems clear, however, that economic textbooks never envisioned the circumstances the world economy faces today.
Though they may have temporarily kept financial markets and global economies from collapsing in the Crisis (2008/09), central bank ‘monetary easings’ and near-zero interest rate policies have reached the point where they are actually headwinds for the economy. In the US, Europe, Japan, and even China, pumping new money into the system (‘money printing’) has morphed from a one-time temporary aid to a seemingly endless cycle of artificial systematic support. Similarly, central bank interest rates (’price fixing’) remain at historic artificial lows and are being held there indefinitely for the same reason.
Monetary easing and ultra-low rates are not working as central bankers had hoped. Some say monetary policy itself has become ineffective at stimulating the economy because of the ultra-low rate environment. And in the eurozone, central banks print ‘fake’ money to support insupportable sovereign debts, while simultaneously imposing harsh regional austerity programs with similar intention – a complete ‘disconnect’ from common sense and reason.
In summary, actions of bankers and politicians meant to fix the problems are in reality slowing recovery and stealing the lifeblood of our economic future.
The Euro area is in recession. By most definitions, Southern Europe is in depression. Eurozone forecasts call for continued recession – after already five years of contraction. The United States may appear to be faring somewhat better. However, US growth in 2012 was little more than anemic, with fourth quarter 2012 GDP posting a meager +0.1% (revised from the original -0.1% reported earlier). Meanwhile, Japan has basically been in some stage of deflationary recession for years, and even powerhouse China’s growth has been more than halved.
These economies play lead roles in the largest coordinated monetary intervention and ‘free money’ policies the world has ever seen. All are acting under the belief (we would call it ‘hope and prayers’) that their efforts will reignite economic activity and ultimately resolve the world’s mountain of unmanageable debt. The two are indeed inextricably connected, and they are failing on both counts.
Cheap money can have unintended consequences, especially when that seems the only game plan and the body politic appears unwilling to acknowledge the true issues – yet alone demonstrate the ability or unity to act. The consequences are moribund economies that are proving unable to provide real, sustained economic growth – a key requirement for hope of any eventual resolution.
But stock markets climb
Many believe the economy is improving, though acknowledging the improvement is unimpressive. They point to equity market performance as proof.
Today most major market stock indices are near or at highs not seen since before the Financial Crisis. However, the split between what financial markets and economic fundamentals are stating about the future is confusing.
Equity performance does not necessarily indicate economic health, and today’s current high stock market valuations speak little of our economic reality. Though recouping losses sustained in the Financial Crisis, equity market performance in the past four years has been almost entirely driven by the zero-interest and easy monetary policies we describe. All that new money (essentially new debt) is flowing into financial markets and speculative assets.
Wharton School Professor Franklin Allen agrees. Summarizing why markets are doing well while the economy falters, he believes “quantitative easing is a big part of the explanation.” Central bank policies are at fault because “at least part of the money is going into equities and driving up their prices.”
Barclays Capital is more direct, telling wealthy clients in their recent Global Economics Weekly, “We see the new highs in equity prices as a product of extreme levels of central bank support.” (You can substitute ‘money printing’ for ‘support.’)
The graph above clearly demonstrates the point. The American S&P 500 stock index performs quite well during the periods of massive US Federal Reserve ‘stimulus’ programs, but prices fall off considerably when the Fed’s ‘piggy bank’ is taken away! Also notable is the ‘law of diminishing returns,’ as each successive monetary injection has less positive effect on equity valuations.
The graph for the S&P is not unique. It is strikingly similar to that of other ‘money-printing’ developed economies and their stock markets.
Using our example, we note that fundamental data show corporate profits have improved. Many large companies appear healthy, and their profitability has expanded since the Crisis five years ago. Similarly, there can be no argument that large multi-nationals have record cash on hand, and companies are not dangerously over-levered (indebted). All are important fundamental factors from a market valuation viewpoint.
However, the underlying reasons for these seemingly robust corporate profiles have a much less sanguine reality and are indicative of why the endless monetary manipulation is now actually having decidedly negative effects on global economies.
Companies are not investing in new plant, equipment, and human talent. They have trimmed their payrolls to the bare minimum, reduced worker hours where possible, and drastically cut overhead and expenses.
Indeed, firms are hoarding cash and paying down debt. They are uneasy about the economic future, government policy, and their own survival. With business and productive investment thus seemingly immobilized, the economy remains weak. All the excess liquidity then flows into speculation, pushing financial assets and equity markets to new and illusory heights. In other words, equity markets are being artificially inflated.
Most of the stock market rally since 2009 can be chalked up to central bank policy – which we fear is creating even more downside risk. Walter Zimmerman, Senior Technical Analyst at United-ICAP, warns, “The stock market is no longer a lead indicator for the economy. It is instead reflecting [central bank] manipulation. Pushing the stock market higher while the real economy languishes has resulted in another bubble.” (More on this topic in Part III of our Series.)
‘Cheap money’ is not driving the economy forward at any meaningful speed, but it is producing a very marked acceleration in speculative asset valuations. In sum, central banks’ easy-money agenda is producing economic results that are quite opposite to those intended.
A ‘Grand Disconnect’
Central bank policy has clearly shown a ‘Grand Disconnect’ between intentions and results. It has proven to be a costly misapplication of resources. The new money is being used to support old debt and new speculation, rather than to build and increase productive economic resources.
Massive liquidity and low interest rate policies are not promoting increased production, meaningful new jobs, and fruitful business investment – the key ingredients required for real economic renewal and sustainable growth.
As a country’s economy stalls or shrinks, so do its industries, jobs, and prospects for future improvement. When taken together with debtor nation political dysfunction and excessive regional austerity and fiscal consolidation measures, the outlook is not bright – and the risks are to the downside.
Sucking the lifeblood out of already struggling economies causes economic activity to decline further and revenues to continue to shrink. The possibilities of paying – yet alone servicing – difficult debt loads evaporate as well. The economy then faces even more financial turmoil. Indeed, it can become a vicious spiral downward!
Of course, this speaks nothing of the huge social costs already being experienced.
From our perspective, there are increasing signs that central bank policy and governmental market manipulation are producing unintended consequences. The collateral damage is severe and increasing. The results are robbing us of our economic future. Ultimately, the effects may be devastating.
In this new global paradigm, individual savers and investors need to be informed and prepared. There is a future, though the perspective on the horizon may be unclear. A planned course of action is imperative to preserve (protect) hard-earned capital and to align possible strategies for the unknowns still unfolding. We will offer our perspective and some suggestions in Part III: “Brave New World.”
Note: The viewpoints expressed herein are solely those of the author and are not necessarily those of any institution or organization with which he may have an affiliation.
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Featured image/Friedrich Haag, CC BY-SA4.0
