Repeating the same mistakes in the financial crisis

The solution to our financial woes includes cleaning our exhausted system and replacing it with technology and high value-added industries. Exactly what we're not doing

Groundhog day?
Daniel Lacalle
On 28 January 2013 13:53

How do we get out of a debt problem and stagnation that only worsened with stimulus? The concerns over an all-out global currency war, triggered by Japan's latest move, were discussed in Davos as central banks become increasingly politicized and intervened.

Japan's Prime Minister, Mr. Abe, said that with the dollar above ¥85, "companies that haven't been paying taxes until now can pay taxes" because a weaker yen lifts profit. Really? Or is it a case of exporting at no profit because planning was made at an unsustainable yen exchange?

Devaluation – great idea. It 'improves' competitiveness, debt 'disappears' as the currency in which it is denominated loses value, and everything starts again. Yes? Well, no – because the fundamentals of the economy do not change, and we have sunk the credibility of governments and the financial system. This pyramid scheme does not work without confidence.

We are currently in a period that will be studied in the future in business schools because of the obstinacy of repeating the same formulas that created the crisis over and over.

According to an analysis by RBS, in 2013 most Asian and OECD central banks will engage in some form of aggressive currency manipulation scheme. In this race to zero, once you pop, there is no stop. In 2013 it is estimated (by UBS this time) that central banks will expand their balance by 15 percent – or $1.5 trillion. Hey - It didn’t work the first time, so let's repeat it!

From defeat to defeat until the final debacle

So we get low rates, disproportionate spending in high-risk assets with poor results, impoverishment, and useless stimulus plans. The consequence is more debt and low productivity economies. And the solution, according to our governments? Repeat it: "Stimulate to combat unemployment."

In the US it’s taken $5 trillion of stimulus to reduce unemployment by an imperceptible amount, with an average bill of 'only' $2.5 million of additional debt for every job created – even if we accepted the ridiculous premise that all jobs gained were a result of stimulus and monetary policy (an implausible starting point, because most of the job creation is coming from the oil sector). In the UK, after stimulus, Olympics devaluation, and zero rates, the country faces a triple-dip recession and stagnant unemployment. The solution? Repeat it! 

To repeat such a ‘successful’ formula, governments have to steal from the pocket of savers: taxes, depreciation and manipulation of the cost of money. And, of course, unemployment doesn't fall, certainly not because of government intervention. Textbook financial repression version 2013.

Repatriation of gold and "competitive" devaluations

Central banks are devaluing currencies to "improve competitiveness and lower unemployment". Last week we saw Germany's gold repatriation decision and now we read about similar decisions in other countries like India and Azerbaijan, while even Switzerland debates the possibility of repatriating its precious metal reserves. The Standard Bank physical gold index reached historical highs – physical gold, not financial derivatives; an attempt to ring-fence value amidst financial uncertainty.

Repatriation of gold reserves is no accident. It is part of the wider mistrust of the global monetary system that is out of control. Even a senior Chinese official said on Friday that the US should cut back on printing money if the world is to have confidence in the dollar.

Consequence 1: risk soars

One effect of this currency war is the pursuit by investors of yield at any cost to compensate for the fear of the loss of value of money. That is, less interest accepted for higher risk.

According to Bloomberg, the demand for junk bonds and debt of troubled countries has soared to levels of 2009. Companies on the verge of bankruptcy issue bonds with demand exceeding supply by ten times. 

Spain has capitalised on this demand for bonds. Between the state and corporates, bond placements exceeded €42 billion in January. Is Spain on the recovery path Pr is this reallocation of global risk? Investors looking for a bit of yield?

The overall bond bubble is magnified including so-called high-yield. Do you remember Michael Milken and Drexel? Repeat!

Consequence 2: unemployment doesn't fall, but inflation rises

It still amazes me to read that some people think that monetizing debt creates jobs. Unemployment is reduced when economic activity recovers, when we see real private investment. When we establish a monetary bubble, the effect is counterproductive, because money is invested in short-term financial assets.

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