Many people seem to believe that the Eurozone’s monetary problems, caused by economic over-regulation and intervention (e.g. the common currency), can be solved by imposing even more regulation and intervention (e.g. fiscal integration).
But what kind of track record do governments really have when it comes to manipulating the fundamentals of the real economy?
It Is Not Just the Euro…
Whilst the impact of fiscal policy is rather contemporary, the use of
monetary policy as medicine to improve economic health has long-term
implications, comparable to the side-effects of substance abuse. There
are numerous examples of how government’s manipulation of money flows
and exchange rates has lead to short-term economic euphoria (usually
correlated with election cycles), but at the cost of creating long-term
imbalances that end up being reversed with a significant element of
- The credit bubble leading up to the Great Depression of the 1930s
was created by the US trying to help the UK keep the gold standard after
World-War 1. The Fed bought British pounds with freshly issued US
dollars, which increased the US money supply (creating a lending driven
economic boom, leading to debt levels which, though large in size, were
still smaller than what can be observed in the global economy today
before the economy reversed)
- The crisis in Latin America in the early 1980s was similarly the
result of currencies initially being pegged to the USD, driving up
domestic money supply, creating negative real interest rates leading to
huge debt imbalances (in USD)
- The Japanese real estate bubble between 1986-1991 (which Japan
still has not recovered from) was the result of a lending spree
occurring because the Japanese pegged their currency to the USD to
stimulate their export industry (the central bank had to print Yen to
buy USDs, which increased the domestic money supply and kept real
interest rates in negative range)
- The Asian Crisis (1997) was also the result of an initial USD peg
among a select group of Asian economies, which lead to unsustainable
inflation, asset bubbles and debt levels
- The pegging of the Dirham to the USD lead to too lax monetary
policies which gave fuel to a massive real estate bubble in the United
Arab Emirates that pricked in 2009 (prior to that, real interest rates
where in negative range for about 7 years). The UAE was able to keep its
peg due to significant oil revenues, however is still struggling with
the aftermath of high inflation
- Now China is overheating with inflation because it cannot control
its money supply as the result of the USD peg. Inflation is at 6.5% and
real interest rates have been negative for a long time. China may need
to de-peg sooner rather than later, if it does not do so, it is risking
further build up of an asset bubble that threatens economic stability. A
de-peg will inevitably lead to a USD collapse, potentially creating
double digit US inflation almost overnight and putting further strains
on the Eurozone as exports will become massively uncompetitive – to come
on top of the zone’s already huge structural problems.
And the list can go on and on….
A Change of Paradigm
A crisis yet to come is founded in the widely celebrated central bank
interventions from Greenspan and the Fed. They have succeeded only in
postponing major economic re-adjustments which have been overdue since
Through counter cyclical monetary policies during what initially must
have been smaller recessions (which technically are nothing but
temporary periods of lower economic growth due to businesses and
consumers re-paying debt instead of consuming and investing), the Fed
decided to cure the symptoms experienced by having too much debt (e.g.
low growth) by lowering interest rates, which stimulated even more debt.
With progressively lower interest rates, consumers kept the economy
growing by consuming with borrowed funds, and debt has increased to
levels never before seen in history (US public and private sector is
debt is now close to an astonishing 260% of GDP, roughly quadrupled
since 1982, and around 50% higher than before the Great Depression).
And when the private sector in 2008 eventually was unwilling to
continue their loan financed consumption spree (even with interest rates
close to 0%!), borrowing (and spending) was instead taken over by the
US government, sold to the public as “Keynesian counter cyclical fiscal
The Fed’s overly expansive monetary policy of the late 1980s, 1990s
and throughout the 2000s, has not only created a massive debt overhang,
but have also sustained artificially high domestic GDP growth rates
(driven by the debt fueled consumption) and supported global confidence
in the USD as a reserve currency. The rest of the world believing in the
“almost supernatural” powers of the Fed (remember the t-shirts saying
“in Greenspan we Trust”?) has contributed to overvaluing the USD vs the
currencies of trading partners. This has in turn driven the US from
being a manufacturing driven economy focused on production to a service
driven economy focused on consumption (to put it simply, US cars became
too expensive to produce, so people found work at Burger King instead).
Throughout all this time, the US public accepted the structural
economic shift towards low-earning service sector jobs, as they were
still able to keep consuming, financed by the progressively cheaper
Back in the really old days “bread and circus” used to do the trick. Today it is all about “iPhones and Playstations”.
Greenspan was by some declared genius, but truth is that the policies
undertaken by the Fed under his management have probably damaged the US
economy more than ten nuclear disasters or a hundred terrorist attacks.
The Fed has acted similar to a doctor prescribing more heroin to cure abstinence symptoms stemming from heroin abuse.
As time goes, the patient develops increased tolerance and needs higher
and higher dosages to feel good. The last dosages administered are so
extreme that they impose a threat to his life, and though no-one expects
them to cure him, at least he may have a final hell-of-a-party before
he must face the real underlying sources to his pain (that is, if he is
lucky enough to survive. More about that in a previous article, “The
Convergence to Normality
Today’s 40-year old fiat currency regime is only a blip in economic
monetary history (spanning back thousand of years) and will soon make
way for the next paradigm shift, which may well be a return to the gold
standard and the abolishing of how central banks work today.
Central banks started out as simple reserve banks to ensure stability
of commercial banks (which issued gold certificates, at the time the
equivalent of money).
Somehow, potentially deluded by perceived progress of economic theory
(or simply a case of bad memory following 30 years of post WW2
stability), their mandates grew to encompass tasks requiring superhuman
wisdom, divine integrity and foresight…
Before we return to sanity, the next economic paradigm will be a bearparadigm.