Broken Capitalism

Broken Capitalism has moved to http://www.bigthoughtslittlethoughts.com/brokencapitalism Please come join us over at Bt;lt!

Any fool can see that inflation is coming to the UK due to the collapse of sterling compounded by the May government’s preference for a “hard” brexit.

And it’s not just a simple, one off adjustment as many would predict. It hasn’t happened yet because companies that buy good overseas are still using currency hedges - but when those run out they will have to put up prices. Different time durations on different hedges mean those effects will be spread out and incremental - some businesses taking the opportunity to push even higher to mitigate future risk (Apple has already pushed up c.25%)

The problem the BoE have is that any announcement of further monetary easing has been justified in the past on the basis that inflation is so low - but in reality, they’ve just been propping up asset prices to prevent a stock crash.

Now, they can’t use that excuse without exposing themselves as fools or coming clean about the real gravy-train purpose of their actions.

And of course, everything in the UK now looks cheap, so the FTSE is soaring today:

Although obvious, this is still going to be confuse many, and be pointed to as proof the UK economy is doing well.

What the last 8 years have taught us is that just because you can pump up the value of existing things easily with central bank intervention, that does not necessarily cause money to flow through to the wider economy.

Dropping interest rates/withdrawing bonds from the market does push the savings money into stocks and property - but the companies themselves don’t have that money to invest; it the people who hold the shares that just get a bit richer (on paper).

Low rates push up to the cost of dividend paying stocks because people are prepared to pay more&more for less&less % yield as returns from savings accounts fall - so stocks / rentable housing etc tend toward the same yield as the prevailing savings rate.

Note: the stock pumping process is somewhat divorced from whether the companies in question have actually done well, yet politicians and company boards point - look the stock market valuation is higher that it’s ever been, we must be successful!

But there is scant trickle down, as productivity growth is almost universally low or negative (mostly due to globalisation and the de-skilling of the west to be fair). Even the corporate sector itself is in an earnings recession.

So a change of strategy is needed by central bankers. But to what? If you’re going to run a pyramid scheme, then maybe even money printing to fund infrastructure / healthcare / education is a better bet than the current one which boosts only the pockets of the few

OUR CURRENT ECONOMIC MODEL IS NOT CAPITALISM because there is little Free Market involved.

It is corporatism.

We want to utilize cheap foreign labour to (a) make our companies more profit and (b) make goods cheaper (a form of deflation that makes us all feel wealthier).

Allowing the free market to function naturally would mean cheap foreign labour getting richer and eventually normalising income between us and them, but:

We don’t want to get poorer. “We” also don’t want freedom of movement on the whole - so a natural free market where people willing to come to the US to drive taxis for a fraction of the wage as our own drivers isn’t allowed to happen. We just want cheaper goods and more profit. So we have immigration controls and trade agreements (usually duplicitously labelled “free trade” agreements).

However, our well paid jobs are also being moved overseas. That has the effect of either reducing consumption or increasing indebtedness. The latter is the preferred option. Couple it with monetary policy (0% rates, QE) that artificially raises the price of assets (so we all feel richer again) and you can keep going (for quite some time it transpires) without income / productivity growth - even with those in decline.

But debt is essentially borrowing earnings from the future, so is this going to end well? No. But when is it going to fall apart? Only when we either admit we’re not as wealthy as we thought - or there is a shock to the system. No politician / central banker will allow the former, so the latter it is.

So when will that be? It’s worth spending some thinking time on…

The FT reports that the UK government is struggling to find people to take it’s printed money in exchange for buying their own gilts back because pension funds and insurance companies don’t want to sell.

Why? Well what else will they buy? Extended asset inflation means most classes (all classes?) of assets are in overvalued bubble territory with yields pushed down toward the parlous returns from artificial interest rates.

Compounding this, lower interest rates make it more difficult for pension funds to meet commitments, encouraging them to hold more long-term bonds! Mark Carney - Bank of England (BoE) chair is attempting to push with one hand and pull with the other. We are reaching the limits of extreme monetary policy.

The sad thing is that it’s even being attempted - the Bank of England (BoE) still clings to the idea that freeing up this money will lead to investment and spending. IT DOESN’T. These generally risk-averse people just buy other assets - pumping up the price and adding air to already stretched bubbles.

But what else can the BoE do?

A: Direct to citizen money printing If you’re going to print money, you could pump it directly into people’s bank accounts. Will it cause inflation? That’s actually welcome ATM. However, like pouring oil on a wet-wood bonfire (if you’ve ever done this) it burns off dramatically for a short time, then dies back down to almost the same sustained level (but hey! everyone had a great time…)

B: Infrastructure spending Pump the money into things that would normally require huge government borrowing - building airports, hospitals, fixing roads, improving the NHS with more doctors + nurses etc. This both raises employment and makes things better. However, it’s a very slippery slope as if it goes on for too long (and let’s face it, as a decade of “emergency” rates has shown, once we get a taste for the drugs it’s hard to come off) politicians will no longer see the need to raise money through tax (why bother when you can just print it?) and the economy turns explicitly into a Ponzi scheme. Our continued success would rely on other nations (and markets) still taking us seriously - unlikely… UNLESS the rest of the world is also engaged in it up to their necks.

(note: QE is essentially a Ponzi scheme, just obfuscated so much that people can convince each other it kind of isn’t)

C: Admit that growth is over It is politically impossible to speak of the Elephant in the Room and say we are simply not as wealthy as we think; our assets (both corporate in terms of shares and bonds, and personal in terms of property) are not worth what they say on the sticker; real interest rates (the ones people are prepared to use) are far higher than 0%; and indefinite growth is over in the UK at least (and probably the rest of the western world) meaning living standards have peaked.

D: Puff smoke in the air and wait for the system to naturally reset. It’s inevitable, and making these notional attempts to keep the band wagon going means you can at least say you were trying - so it wasn’t your fault.

TL;DR:

• Monetary stimulus does not lead to growth (only asset inflation)
• High asset prices != a prosperous economy for anyone other than rich
  
• It’s broken and central banks have run out of ideas, but (a) dare not use fiscal stimulus; (b) dare not admit that constant growth isn’t possible; © dare not allow asset prices to normalise. An impasse, then

Ah, loose monetary policy. No-one really knew what would happen, but now it’s clear. Precious little of the freed up money ends up doing anything even remotely useful, the vast majority simply pumping up asset prices. The asset holders (generally the already wealthy) get wealthier, and the non-asset holders (e.g. younger people) get further and further away from them.

Why Interest Rate Reductions Don’t Work Anymore

As intended, reducing rates does indeed make savings pointless, but it turns out that the people who should have been encouraged to then go and spend that money were SAVERS - and thus simply poured all their efforts into seeking out other holes in which to bury their money. They buy shares in companies (for the dividend - until the share price is so high the dividends are as palpable as the savings rate); they buy bonds (ditto) and they buy property (whose rent has an upper ceiling set by earnings, even if values don’t meaning yields also drop).

If you run a 0% rate for long enough, the returns from all other yielding assets also tends toward 0.

IF you want the type of people pre-disposed to SAVE their money to SPEND it, you need higher interest rates to give them more income and the security they feel they need for the confidence TO spend.

But what of cheaper debt? That does show benefit for a while but once everyone has borrowed as much as they can from the future, the future arrives and they have to start paying it back.

No couple who bought a house at overinflated prices with a joint 35 year mortgage will ever be able to move up without non-debt funding (i.e. inheritance) and has scant spending power left over for consumables. So that’s the asset rich older generation of savers AND the asset poor over indebted younger generation both unable or unwilling to spend.

Why Quantitative Easing (QE) Doesn’t Work Anymore

Basing your search for growth on ever increasing consumer spending is hard to make work, just like any other pyramid scheme. So what else can we try? QE. Yes, that magical way of printing money without explicitly SAYING you’re printing it. And it really does seem like magic as it avoids the rabid inflation that terrifies governments into not printing money for useful things. Well, you do get inflation - just of stocks and bonds and buy-to-let flats - food and fuel and things that the official inflation measure examines actually go down due to dwindling demand from actual real people.

The money created by QE needs to find a home - and because the people who owned the government bonds prior to them being bought with fake QE money were RISK AVERSE (savers, pension funds etc) - they don’t think - GREAT! MONEY! let’s re-invest that in machinery and jobs! No, they search for other RISK AVERSE places to stash it of course - more government bonds, gold, shares… in other words it further inflates the price of assets - pumping up those increasingly disassociated barometer’s of the economy - the stock markets.

So what have we learnt?

• Asset prices move inverse to interest rates (to a level where their yield tends toward the interest rate set)
  
• Money printing via bond purchases just gives bond purchasers more money - not businesses / consumers to invest / spend
• Share prices are still clung to as a barometer of the health of an economy

MAYBE - JUST MAYBE - THESE THINGS ARE KEEPING THE LIFE SUPPORT SWITCHED ON THOUGH - and the world would have collapsed without them.

Is that the best we can say about them?