GOING POSTAL 20/8/18

[Part 1 of “This time it will be different” appeared as Going Postal last week.]

PART 2

THE SCOURGE OF CREDIT EXPANSION – THE SYSTEM’S DEMISE COULD BE SOONER THAN YOU THINK

The monetary conjuring trick employed after the last crisis, described in Part 1, required central banks to purchase government bonds from pension funds and insurance companies, paying for these financial assets with the newly printed money so that it then flowed into the banking system. Simple. It’s an operation called “quantitative easing”. No, it’s not a laxative – just a straightforward conjuring trick of teasing money (that looks like real money but is counterfeit) out of thin air!

The early receivers of this money, usually in the form of bank loans or similar instruments of indebtedness, benefit hugely because prices in the economy have not yet risen in response to the latest monetary influx, and are based on the earlier, pre-dilution, quantity of money. The tendency is for the first receivers of the new money to spend it – after all, there’s little point in hoarding it when, by this time, the central bank is shredding interest rates. So the newly enriched class will lash out on assets previously unaffordable, creating bubbles in real estate, equities, luxury goods and works of art, prices of which now go through the roof.

….enriched some and impoverished others

The losers (there are always losers!) are, of course, those now facing the higher prices prevailing in the wake of the money injection. The government’s manic measures, far from stimulating the economy, have left it exactly where it was, but in the process have enriched some and impoverished many others – particularly those who get by on low wages, benefits and fixed incomes, notably retirees!

The 17th Century economist Richard Cantillon explained this concept of “relative inflation”, or a disproportionate rise in prices among different goods in an economy, now known as the Cantillon effect.

A repeat performance wearing different masks

The space between credit crises seems to be just long enough to blunt our memories. One needs to be reminded of even the very first lesson in economics: statistics lie! Inflation of the money supply inevitably works its way through the economy and triggers price inflation that the Consumer Prices Index reliably under-reports. Treasury statisticians change the ingredients that constitute its measures – aided by commercial pressures that cause “shrinkflation”: the bars in a Kit-Kat are shorter and the gaps between humps in a Toblerone bar are wider! All these tricks contrive to delude consumers that like-for-like price inflation (which, correctly measured, is far closer to 10%) is somehow manageable!

official inflation figures have been artificially contrived

But, as the old saying goes, you can’t fool all of the people all of the time. Consumers don’t need graphs to confirm what they already know instinctively from their bills and going shopping: official inflation figures have been artificially contrived. The central bank, to avert a crisis of confidence and a further loss of purchasing power, is compelled to raise interest rates – the markets are no longer prepared to play ball with the official disregard of time-preference values that represent the real relationship between immediate and delayed gratification of material needs and wants.

New sense of risk awareness

The unmasking of the charade described in Chapter 1 reveals the extent to which capital has been misallocated since the previous bust and highly geared financial intermediaries find themselves at risk when interest rates rise, even gradually. New business start-ups delay their launch dates in the pervasive atmosphere of risk-aversion, heralding a potentially systemic risk for the banks. Individuals and small businesses now favour liquidity over bank deposits, contrary to the efforts of central bankers to discourage cash holdings by promoting electronic transfers, contactless cards and threats of tax evasion charges.

The risk that a bank with customer deposits may be unable to vouchsafe their withdrawal, will cause customers to switch banks to one deemed safer, while the central bank will shore up the dodgy ones by recycling surplus deposits held elsewhere – all behind closed doors to conceal the extent of the problem.

Reaction from a banking coterie facing systemic collapse is just about foreseeable. But how will the endgame play out? In a recent issue of “Goldmoney Insight”, Alasdair Macleod, whose own insights have inspired much of this essay, countenances the possible demise of fiat money as valid currency within the next 18 months and, as an amateur in this game, I am in no position to gainsay him.

these are the signs and portents

But there are indeed signs and portents that collectively militate in favour of Alasdair’s timescale:

(i) The numbers swilling around right now are too vast to have any recognisable meaning: global debt (that is ALL debt, consumer, business, and government) stands at an estimated $247 trillion, which is over a quarter of $1 quadrillion – (there, I used that word first!). The interaction between this incomprehensible level of debt, totalling close to one-third of global annual GDP (the world’s entire annual production), and the rapidly spreading trade war being waged among our idiot leaders is, putting it mildly, explosive: these debts, owed mainly to banks, central banks, other financial institutions and sovereign funds, that conspired to facilitate its growth in the first place, collectively form a bloated circular bubble. But any notion that it can be serviced must be premised on rising incomes – a virtual impossibility when incomes are being squeezed by the expanding trade war’s impact on prices.

(ii) The impact on business profitability of rising interest rates is undoubtedly a current factor. It is true that rates have been suppressed for so long that interest charges have been denied their place in the economic firmament, and the choice of timing in their reappearance is irrational and haphazard. Banks, unanchored to principle, act indiscriminately and seize the opportunity to get as much as they can from businesses already beleaguered by straitened circumstances.

(iii) High Street retailers whose business models are just beginning to acclimatize to the severe impact of internet shopping are now facing the additional punishment of losing basic credit insurance from underwriters sniffing the spread of retail decline. Retailers are granted normal credit terms (usually 1 to 3 months) by their suppliers, provided those suppliers can buy insurance against default. Even an enforced reduction from 3 month’s credit to one month will have a material impact on a store group’s working capital requirements. A reduction in affordable credit insurance may therefore have been a strong contributor to several store closures, or near-closures, by household names such as Multiyork, BHS, Toys ‘R’ Us, Mothercare, Maplin, Poundland, Palmer & Harvey, Jaeger, Austin Reed, Beales, MFI, Woolworths, Debenhams, Carpetright and House of Fraser – now acquired by Mike Ashley of Sports Direct.

(iv) These and related factors (including onerous lease terms) will combine to create a state of affairs implacably averse to the restitution of normal terms of trade and, notwithstanding empty reassurances from the great and good, the trust implicit in any workable system will evaporate – and it will be each for himself.

Postscript: The breakdown will be followed, of course, by reassurances from the usual suspects, Lagarde, Draghi, Carney, Hammond and the usual entourage of economic ignoramuses, that this time the lessons have been learnt, and mechanisms have been put in place to ensure that the credit cycle will not wreak havoc ever again! If you believe this, you are condemned to studying my series of “Economic Perspectives” and “Going Postal” posts!

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