Published on November 15, 2016
I’ve never been able to master that special ability to blow a really good bubble-gum bubble. I could get a small bubble started but just didn’t have the technique required to make it any larger than about a passionfruit. I’m not sure what it was that defeated me, but one thing I wasn’t keen on was the thought of what would happen when it burst. Asset bubbles are the same.
Clearly, I was not destined to be a central banker or trader in the financial markets. It appears to me that the global financial system is being managed (or mis-managed) by people who were clearly good bubble-gum blowers when they were younger. Why? Here’s my theory.
1. Ability to inflate
The central banks around the world, especially the Federal Reserve and ECB have become bubble-blowing experts, regardless of how their face will be plastered by sticky stuff when the bubble bursts. They have fuelled the extraordinary rally in bond markets as long term yields have gone in to negative territory and propelled debt-funded, asset price growth among other outcomes.
William Hague has nailed it in my view in an article he wrote in October titled Central Banks Lose the Plot. To quote:
‘Eight years after the GFC they [the central banks] are still pursuing emergency policies that are becoming steadily more unpopular and counter-productive.
‘The trouble is that eight years later they are, to varying degrees, still doing it. Like doctors keeping their patients on a drip many years after an operation, they are losing credibility and producing very dangerous side effects.’
In a frank discussion with Central Banking magazine, Otmar Issing, the European Central Bank’s first chief economist, noted that the ECB is becoming dangerously over-extended and that the whole European project in unworkable. ‘One day, the house of cards will collapse,’ he said. I thought, I know that story and I’ve seen the movie as well. But wasn’t that movie about 2006-08?
But then I read about what’s going on with Deutsche Bank (see below), Banca Monte dei Paschi di Siena (Italy’s oldest and third largest bank having been formed by statute in 1472) which has been bailed out twice by the state and raised €8 billion in capital in the last two years. It’s next attempt at raising an additional €5.4 billion is underway now, as it lays of 10% of its staff, shuts branches and sells off assets.
Concerns about Monte dei Paschi di Sinea and the ‘potential rescue’ that would require a bail-in by some of the bank’s bondholders (i.e their bonds would be converted into shares) reminded me of the banking crisis in Australia in the 1890s which precipitated the worst depression Australia has ever seen. More specifically, it completely ruined that so precious and central of things in banking, trust in the system.
This is not a case of ‘the more things change the more they stay the same.’ This is a case of history repeating itself, time and time again. If the central bankers, international and European banking institutions don’t follow their own rules, how on earth do they expect anyone to trust them.
You can’t blow up a bubble-gum bubble past your technique and ability to inflate it. If you do, it bursts, as all bubbles of all varieties always do.
2. Persistence in the face of diminishing returns
Just as with bubble-gum which gets less elastic and loses its responsiveness after a period of time, central banks around the world keep reverting to QE despite the law of diminishing returns and, in fact, in the face of embedding serious ‘unintended consequences’ on the world’s economies.
QE has done next to nothing to stimulate growth. Mostly, its stimulated asset prices, both in the share markets around the world and in some property markets, especially in Sydney where I live. Just think Monopoly and you’ve got what the Sydney property market is like. Unlike Monopoly, however, most of this bubble is fuelled by increasing levels of debt based on low interest rates.
What I can’t work out is why the smartest people in the room can’t work out what they need to do. We’re now 8 years on from the GFC. Emergency/temporary measures are just that. We’re way over that now. It’s like the central banks have decided to restructure the game of pass the parcel so that no-one ever has to leave.
They don’t want to act and in their inaction we have deflation, asset bubbles, zombie companies, banks (Deutsche Bank) that get special treatment when they have stress tests, other banks who obfuscate when their employees create 2 million fake customers and credit card accounts (Wells Fargo) and still pay their executives over $US25 million a year – John Stumpf and Carrie Tolstedt included.
No line of responsibility, accountability anywhere here.
And the best that the World Bank and IMF can come up with is that the central banks can’t do all the heavy lifting on their own and that governments have to pick up their efforts.
What this disingenuous statement ignores is that the world’s bankers have taken the easy route, whole-heartedly supported by governments seeking easy solutions so that they can get re-elected.
What they have collectively created is an extended period of global economic downturn, increasing debt, lower productivity, higher unemployment, political instability and one of the biggest moral hazard plays in history.
3. When the bubble-gum bubble splats all over your face
This was the thing that really held me back from mastering the technique of bubble-gum bubbles. The thought of that pink, sticky stuff all over my face was too yucky. In reality I assessed the consequences, made a decision based on these for me and took responsibility.
The world’s financial bubble-gum blowers have taken a different approach, they’ve decided to keep, ever so slowly, blowing up the bubble in the full knowledge that there’s no such thing as an orderly deflation . . . the bubble will burst. And this is called, in banking and financial terms, moral hazard. And it’s now overwhelming.
James Aitken, from Aitken Advisors, calls the negative interest rate policy being followed by many countries as ‘a bizarre curiosity’ and that the signals for a readjustment have been flashing since July.
He notes that for about 30 years markets went up by 11% a year, inflation averaged 5% and interest rates were around 7%. Now we’re in an environment where interest rates and inflation are virtually zero. Growth is harder to come by . . . and where do you ‘come by it’? Borrowing at low interest rates to fund unproductive asset purchases.
To quote Otmar Issing again in relation to Europe but it’s really the story of the world right now.
‘…at some point in the future, Europe will be hit by a new economic crisis. We do not know whether this will be in six weeks, six months or six years. But in its current set up the euro is unlikely to survive that coming crisis.’
When the next global downturn happens we’ll all be starting with higher levels of debt, unemployment, lower productivity and political instability.
In an odd way the polities of many nations around the world understand this, are railing against the obfuscation, arrogance, lack of political leadership, endemic denial by the central bankers and outright denial by the masters of the universe.
Maybe my aversion to having a bubble-gum bubble blow up all over my face is a more common self-preservation trait than I ever thought.