Wednesday, March 12, 2014

They Admit Default

The sovereign defaults in industrialized western nations have begun, at least according to Ambrose Evans-Pritchard:

Britain has just carried out one of the greatest victimless crimes in modern financial history. It is in effect wiping out public debt worth 20pc to 25pc of GDP – on the sly – without inflicting serious macroeconomic damage or frightening global bond markets.

Let me check yields on British sovereign debt…mmm, AEP is correct; there seems to be no reaction to this significant event.

Governor Mark Carney more or less acknowledged this morning that the Bank of England will never reverse its £375bn of Gilts purchases.

Sure – why reverse?  There has been no visible harm to date from the explosion of central bank balance sheets.  Hold the sovereign debt until maturity, and even roll it over at that point.

An entity created by the state creates monetary digits from nothing and then uses these digits to fund the state.  Repayment is not necessary, and as long as inflation as measured by consumer prices stays tame, most stay content.

The Bank has come a long way from the early days of QE when any such suggestion was treated as an outrageous smear. There was a mantra that helicopter money requires a hoover afterwards to vacuum it up.

Yes, it was obvious that all the hand-wringing was for show.

But in a deflationary world there is no clear imperative to do so. The Bank can sit on its Gilts forever. These can be switched in zero-coupon bonds in perpetuity. The certificates can be put in a drawer and left to rot. The debt is eliminated in all but name.

They don’t even need zero-coupon bonds – at least in the US, the Fed returns income to the Treasury: a closed-loop system of embezzlement.

Puritans and Calvinists are certain that there must be sting in the QE tail for Britain in the end. Perhaps so, perhaps the expanded money base will come back to haunt us, but such arguments mostly smack of religion, dogma, and psychological obsession. There is no such determinist force at work.

It isn’t religion (although there is certainly a moral issue); there is damage being done (as has been obvious ever since 1971), but mainstream economists and mainstream press will blame it on something else (as they have done since 1971).  Middle-class disposable income has been stagnant at best ever since the world’s reserve currency came unhinged from any pretense of discipline.

But the blame is always placed elsewhere – cheap labor in Mexico, China, or eastern Europe; oil cartels jacking up prices, etc.

Can there really be such a thing as a free lunch in economics? We will never be able to prove it either way, but on balance it looks like the answer is yes.

The answer is no, and it must be no.

The amount of resources at any given moment is fixed.  When chits are created and handed to non-producers (the state and their crony-capitalists), they are able to compete for those resources – taking them from the productive sector into the unproductive sector.

This, slowly but surely, will lower the average standard of living – or keep the increase lower than it otherwise would have been.

The logic is simple.  Give a measure of copper, tin, and electricity to a budding entrepreneur, or give the same resources to some guy living under the bridge.  Under whose stewardship of these resources will society likely gain greater benefit?

The sovereigns will default, in many ways.  This will be done in manners intended to preserve the system.  Continually expanding central bank balances sheets will do just that, at least until price inflation becomes politically unsustainable or the relative decline in standard of living becomes unbearable.

If there are any deflationists remaining out there, perhaps you might finally pay heed.

1 comment:

  1. The $64 question is whether, with an ocean of debt already in existence, the monetary authority can forever get away with debasing money via credit creation and not affect the asset value of that ocean.

    In a broad sense, all that debt (Treasuries, corporate bonds, mortgages, etc.) represents balance sheet wealth. Mentally, it's part of the money supply. It is huge wealth by any comparison IF the IOU's can be collected.

    For 30 years interest rates have declined, creating the impression that debt-based asset value is "sticky." But is it? The fact that direct debasement of the money supply via QE hasn't led to rapidly rising interest rates (and a commensurate collapse in bond asset value) seems like evidence for "stickiness," but I suggest that this conclusion is invalid.

    Bond (IOU) value is a function of collective trust. Despite the USA's monetary system being divorced from any underlying value in 1971, people's collective trust only grew as IOU's were issued by the solar system load. This violates logic and reason, but then again the USSR destroyed its market economy and survived for a lifetime before inviolable economic law drove a stake into it.

    The lessons people are learning from recent history are similarly wrong. Our current financial/political/economic system's appearance of permanence is much like the USSR's in the 1980's, only when this Wall (Wall Street) is torn down, people won't be dancing.