By the time this is posted I will be somewhere over the Atlantic on my way to Iceland. I will then move onto Ireland where I will spend a few days with the bog monkeys. Since there is some chance I may be tricked into having an adult beverage or two and thus be rendered unable to post, the following has been pre-recorded.
One of the benefits of reading lots of history is you often see the same catalysts, causes and dynamics turning up in the story. The Roman Empire had a lot of problems toward the end, but a big one was their financial structure. Their lack of money led them to do things that made their situation worse. Similarly, the French Revolution had a “want of money” angle to it. The crown was broke and did a lot of very stupid things, as a result of being broke, that compounded the many social problems brewing in the country,
It’s tempting to wonder, for example, what would have happened if Louis XIV had been a bit more prudent or showed a bit more foresight with regards to the financial system of his country. Alternatively, what would have happened if his heirs had better advisers, who would have pushed for mild steady reform in order to slowly bring the French financial system into line with the emerging modern world. Heck, what if Louis XV had simply avoided the mistake of hiring economist John Law.
The best historians, I think, look at the men of the time and ask why were they unable or unwilling to do the necessary things to avoid catastrophe. In almost all cases, there were plenty of people advising the rulers that were making a blunder. In many cases, the rulers knew they were blundering, but events constrained them from acting. In the decades leading to the French Revolution, many smart and influential people knew reform was necessary. They just did not know how to go about it or what they were able to do, within the limits placed upon them, made things worse
Anyway, that’s the vibe I get when reading these stories about the Fed and their deliberations on the economy. Due to the sensitive and precarious nature of their positions, they tend to speak in riddles, but if you are careful, you can tease out some meaning from their public statements. They are very guarded and they reserve their more candid opinions for private conversations, but they rely on the broader financial public to put pressure on policy makers. These staged events are an esoteric form of lobbying.
The United States has a Federal debt that rivals what we had while fighting two empires in World War II. Current debt is close to 100% of GDP and that was the peak during the war years. The difference is we are not battling two empires in a shooting war. Now we are maintaining a global empire. The financiers understand this difference and they certainly recognize the danger it poses. The costs of fighting Hitler and Tojo were temporary and extraordinary. The cost of empire is permanent and ordinary, at least for a while longer.
These debt levels are only possible in the artificially low interest rate environment created by the central bankers. The trouble is they appear to have gone beyond the point of diminishing returns with interest rate policy. We are effectively in a no-growth economy now, despite historically low borrowing rates at all levels. The West is not in recession nor is it facing collapse, but it is exposed. There are no financial tools left in reserve to face the next unknown financial calamity and the bankers know this.
The trouble is the cost of reform is so frightening, no one is willing to face up to it. Interest on the Federal debt is about 6% of annual spending. If borrowing rates returns to historic norms, debt service will grow rapidly. Some estimates say it would exceed 20% of the annual budget within a decade. That’s based on the assumption the economy would not collapse, but rising rates would throttle real estate, tip over bank balance sheets and send the equity markets into free fall. All the attempts to keep the plates spinning have made artificially low borrowing rates the norm. Everything is now based on it.
The Federal government is not about to go bankrupt anytime soon. Federal outlays are about 20% of GDP right now, which is more than manageable. State and local government account for another 20% or thereabouts. Government spending in Germany is at 44% at the moment. It is 44% in Britain and 52% in France. In other words, the US has the same problems we see with all social democracies, but we’re not Zimbabwe. The US dollar is also the world’s reserve currency so that gives the US a much bigger margin for error.
Still, there is a sense you get from theses statements from central bankers is that they know these artificially low borrowing rates cannot go on forever. The longer they continue, the worse it will be when they finally return to normal. It’s just that no one knows how to fix it. The political costs of inflating our way out of debt are too high. Letting rates go up means recession and political panic. A continuation of debt monetization limits the freedom of action of central banks when the next crisis arises and there will always be another crisis.
That is what most likely worries the more sober minded bankers. A decade of 4% inflation would be unpleasant politically, but not end times bad. A slow rise in interest rates would not collapse the world economy either, but it would usher in a long recession similar to the 1870’s, where asset values tumbled for a decade as the Second Industrial Revolution came to an end. The real danger is the unknown crisis that does threaten the foundations of the system and the central banks have no tools to face it.
That’s where the West is at the moment. Things are plodding along, but there’s nothing in reserve in case of a crisis. The US economy is stagnant at the moment, but if it falls into recession, there’s nothing the Fed can do about it. Negative rates are unlikely and probably not effective anyway. The Fed balance sheet is already bloated so further monetization is going to be hard. The financial system is a citadel whose walls need rebuilding, but no one has a clue as to how to go about do it.