Why this is the biggest global bailout in history

Published in The New Zealand Herald, 15 September 2020

Mike Hosking discussing this column on his Breakfast show (16 September 2020)

Judging by the usual economic indicators, you would never guess New Zealand is in a severe crisis.

This tells us something about the economic and monetary system we inhabit. We are living in the economic equivalent of a Potemkin village. It all looks pretty – but it is too good to be true.

Try opening any KiwiSaver statement over the past three, six or 12 months. It doesn’t matter if you are in a cash, conservative, balanced or growth fund: all our major banks’ KiwiSaver vehicles are showing positive returns.

It is not just KiwiSaver balances. House prices are showing solid growth, too.

Last week, the Real Estate Institute of New Zealand (REINZ) released its latest property price statistics. In the past year, the median house price increased by 16.4 per cent. It was a boom across the nation with above 20 per cent increases recorded in Hawke’s Bay and Southland.

If you thought there was an economic crisis or a recession going on, it does not show up in insolvency proceedings, either. For the six months of March to August, 481 bankruptcy adjudications were sent to the High Court. That was 23 per cent below last year’s figure, 40 per cent fewer than in 2018 and 56 per cent below the 2017 numbers.

Even labour market data look fantastic. In the June quarter, unemployment fell to 4 per cent. The last time it was lower was before the Global Financial Crisis in June 2008 when it reached 3.8 per cent.

Investment returns are solid, the housing market is booming, insolvencies are down, and unemployment is low. “Crisis, what crisis?” you may think.

It is not just New Zealand, by the way. Indicators in other countries show weird movements, too.

In the second quarter of 2020, Australia’s household gross disposable income increased by 2.2 per cent. Its equivalent of the wage subsidy, a programme called JobKeeper, combined with an extra $A750 of economic support payments, overcompensated for any income declines in the Covid-19 downturn. Australia’s savings ratio just shot up to 20 per cent. That is not what you would expect to see in a recession.

Some of New Zealand’s numbers are statistical artefacts, like the unemployment rate. If many people left the labour market altogether and are no longer counted, the true figure will be higher than 4 per cent.

Other numbers are temporary. Once the wage subsidy schemes run out, unemployment will increase and household incomes here and in Australia will fall.

However, all the padding around this economic crisis makes it look like a boom. Globally, governments have moved trillions of dollars to prop up businesses, subsidise workers, support the unemployed and run shovel-ready projects. Meanwhile, central banks are printing trillions of dollars and lowering interest rates to keep governments financed and businesses afloat.

This is the biggest global bailout in history. The International Monetary Fund predicts the gross debt position of advanced economies to reach 122 per cent of GDP this year. Just to put it into context, these are levels not seen since the end of World War II.

While government debt rises, central banks’ balance sheets balloon. Twenty years ago, the US Federal Reserve had assets worth US$611 billion on its balance sheet. That figure is now US$7 trillion. Or, expressed differently, the Fed used to hold assets worth about 6 per cent of US GDP back then. Today, it sits on roughly 33 per cent of US GDP.

Following the Fed’s path, the Bank of England, the Bank of Japan and the European Central Bank have all inflated their balance sheets in a similar manner since 2000. The Reserve Bank of New Zealand with its asset purchase programme is catching up fast.

The actions on government debt and central bank assets are closely linked. Without lower interest rates, governments would find it much harder to refinance in capital markets. Today’s debt levels would be nearly impossible at higher interest rates.

This monetary activism is systematic and goes back to the early 1970s. Back then, the world departed from the Bretton Woods system, which linked the US dollar to gold. However, an expansionary Fed struggled to maintain this link.

In 1971, US President Richard Nixon severed the last connection, and ever since the world’s leading currency has been what economists call a “fiat money”. It is a “paper” (electronic) currency with no anchors anywhere in the real world. Nothing limits the amount of money the Fed and other central banks can print.

In the decade after Nixon’s decision, the Fed struggled to rein in inflation. It only succeeded when its then-chairman Paul Volcker took drastic steps in 1979 to make credit expensive through exorbitant funds rates. For the record, the Fed Funds rate peaked at 22.37 per cent in July 1981.

However, after Volcker’s victorious battle against inflation his successors embarked on different policies. Under Alan Greenspan, the Fed routinely came to the rescue when the economy wobbled. Each time interest rates were cut, money flooded the market and the economy recovered. The so-called “Greenspan put” became legendary. Markets could bank on being bailed out by the Fed time and again.

What we are seeing in the Covid-19 crisis is the “Greenspan put” writ large. Every developed country is doing it. Working in tandem, governments and central banks are throwing vast amounts of money at their economies hoping to save them.

In one sense, it is working, at least temporarily. Without intervention, we would now have an unemployment disaster.

However, in another sense, the combination of large amounts of money and low interest rates are a real problem. They zombify parts of the economy by keeping companies alive that would have otherwise exited the market, freeing up resources to be deployed elsewhere. Low bankruptcy numbers, not just in New Zealand but elsewhere as well, are a warning sign that parts of the economy are already the walking dead.

The other major side effect are asset bubbles. Since investment earnings are scarce in a recession with zero or negative interest rates, investors are flocking to anything promising capital gains. Equity, real estate or even rare whiskeys are attractive alternatives to watching your money melt away in real terms.

The Covid-19 recession has intensified Greenspanite policies. However, there are natural limits to cutting interest rates once they reach zero. Little wonder people are talking about fully electronic currencies. Getting rid of cash makes it much easier to implement deeply negative interest rates. It blocks the escape path of holding cash.

And no wonder there is so much hype about the so-called Modern Monetary Theory (MMT). In simple terms, MMT promises even more magical monetary financing than we have become used to.

But is there a natural limit to all this activism? Can central banks hold assets equivalent to 50 per cent, 100 per cent or 150 per cent of their countries’ GDP? And should they? This is not just an economic question but a political one as powerful central banks could dwarf democratically elected governments.

And what about the social consequences? Will societies accept locking the younger generations out of the housing market as asset prices rise further? And will this new money eventually seep into consumer prices and trigger levels of inflation not seen since the 1970s?

The world’s monetary system, having severed the last links to the real world in 1971, is good at fighting contractions in the short run. The way our economic indicators are holding up in this crisis proves that point.

But the constant doses of monetary medicine have turned the world economy into Frankenstein’s monster, sellotaped together by governments and central banks.

At some stage, this monster of an economy will fall apart. Every week of monetary-cum-fiscal bailouts during this Covid-19 crisis pushes us closer to that point.

So, enjoy the relatively positive economic data while it lasts. But do not believe for a second it is sustainable.

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