Central bank monetary meddling spells Groundhog Day for the global economy

The stock market dip in October saw an onset of hysteria regarding the state of the global economy, with many analysts asserting that another sweeping worldwide downturn is imminent. Trade tensions, a poorly timed US fiscal stimulus, slowing Chinese growth, and a messy and uncertain Eurozone have signalled to many that the perfect storm is brewing which may spur another global recession.  

But as most of our economists, policymakers and journalists mull over economic indicators and look towards the horizon for an impending crisis, others argue the symptoms of another global economic catastrophe have been unequivocally fixed in the rear mirror since 2008.

September marked a decade since the bursting of the housing bubble in the US which triggered the collapse of the stock market and economic meltdown felt around the globe. Governments and central banks subsequently took actions to stimulate demand by pumping money into their respective economies and adopting ultra-low interest rates. As a result, the following years have been largely categorised by a worldwide period of both low growth and inflation.

Many adopted the view being peddled under the Obama Administration by Harvard economist Larry Summers that this was the new normal. Summers popularised the phrase “secular stagnation”, asserting that the negligible growth being felt around the globe, which was being propped up by ultra-low interest rates, and historic levels of quantitative easing and fiscal spending was the new standard for developed economies. However recent growth out of the US has rendered any concept of “secular stagnation” as false, as cuts to tax and red tape relieve years of pent up dynamism in the US economy.

But a decade of cheap, easy money and expanding central bank balance sheets have taken their toll. Whilst the US economy may be booming today, policymakers’ actions in response to the GFC in 2008 and the downturn which followed have merely sown the seeds for the next bust.

And given the state of the global economy – another economic catastrophe may not be as far on the horizon as predicted.

The Fed is expected to lift rates for a fourth time this year in December, and is gradually trying to shrink its balance sheet, which has been overstuffed with bonds acquired while battling the financial crisis. This follows a trend of “quantitative tightening” around the globe and signals a backflip on the international monetary policy of the past decade, which several fear bodes ill for markets in 2019.

While Fed Chairman Jay Powell boasts that the performance of the US economy almost seems “too good to be true”, and that “better monetary policy has played a central role” in creating an unexpectedly prosperous backdrop, GDP growth momentum in Asia, emerging markets and Europe is on a downward trend.

The global economy may find itself on a knife edge in the coming years after a decade of near-zero interest rates and $US22 trillion in global quantitative easing. The “better monetary policy” Powell endorses has emphatically failed to fix the underlying structural issues following the financial crisis, and instead simply kicked the can further down the road for future policymakers.

The sobering reality which holds true for the state of both the US and global economy is that decade of easy credit has created only an illusion of economic prosperity.

A handful of economic and market analysts have referred to this prosperity as the “everything bubble”, which describes the dangerous bubble that has been inflating across a wide spectrum of countries, industries, and assets. They assert that central bank QE and the manipulation of interest rates at unnaturally low levels has created an artificial asset boom, which is at increasing risk of bursting as global liquidity is reduced and interest rates increase.  

Within the US alone, credit card, student loan and auto debt each individually sit at over $US1 trillion. Corporate debt sits at an all-time high of 45% of GDP, due to ultra-low corporate bond yields which have encouraged U.S. public corporations to borrow heavily in the bond market in the post-GFC era. Instead of making the productive investments and expansions that were typical of the past, proceeds of the borrowing of corporations have been used to boost stock prices through share buybacks, dividends, and mergers & acquisitions. This in turn has contributed to the S&P 500 to rise by more than 300% from its GFC lows (and over 80% from its 2007 peak).  

Yet even more alarming are the figures coming from the US Budget Office. US Federal debt sits at over $US21 trillion in 2018, equivalent to 105% of GDP. The annual interest expense on this debt will surpass $US500 billion by 2020, and sit at $US900 billion per year within a decade.

In China, strong output growth following the GFC has been supported by booming levels of credit. Fast rising debt and diminishing credit efficiency raise concerns about the vulnerability of the nation to a disruptive adjustment or slowdown in growth. Since the GFC, China’s domestic credit-to-GDP ratio has risen to 235 percent, and a recent IMF study found that in 43 cases of similar credit booms, only five ended without a major growth slowdown or a financial crisis in the immediate aftermath. Additionally, no expansion of credit that started at a debt to GDP ratio above 100% of GDP —as in China’s case—has ended well for the nation.

Elsewhere, the European Central Bank has continued to suppress interest rates following the debt crisis, which has inflated assets and facilitated the financing of unsustainable government deficits. Italy’s new government has made clear there would be no change to their planned deficit size against the EU’s warnings, locking Rome in a political stalemate with the other member nations. With Italian government debt sitting at over 130% of GDP or about $US2.6 trillion, its fellow EU countries are understandably worried Italy’s reckless policies could trigger a debt crisis which has the potential to spell the beginning of the end for the EU.

The debt crisis the world finds itself in today is rooted in the failure of policymakers globally to learn the lessons of the GFC and every other recession in modern history. Through the manipulation of interest rates and overly generous quantitative easing measures, central banks have distorted economic indicators and market conditions. In the aftermath of the 2008 GFC, the extreme policies of central banks to stimulate an economic recovery became normalised, encouraging gross malinvestment and leading to an explosion of personal, corporate and public debt.

These policies have left the global economy disturbingly vulnerable to any sort of economic shock, as central banks around the world attempt to “manufacture” a soft landing for their respective economies. Interest rates will eventually be raised to a point which causes the “everything bubble” to pop, triggering the next global crash. But any central bank response to a crisis will be limited by overstuffed balance sheets and a lack of monetary policy headroom. Additionally, massive government debt incurred following the GFC will restrict fiscal stimulus efforts, and financial sector bailouts will be rendered inexcusable in countries with burgeoning anti-establishment movements and near-insolvent governments.

Throughout history there have been severe consequences of central bank market-meddling, and we are about to learn this lesson once again. Failure of our policymakers to make effective reforms in the aftermaths previous crises mean the global economy is now more vulnerable than ever to a worldwide meltdown.

Worryingly, the scene is set for the ferocity of this meltdown to be unparalleled by any financial crisis before it.

Josh Adamson

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