Free money is just not working

Please find below former Reserve Bank of New Zealand advisor and multiple CEO, Terry “Macca” McFadgen’s, latest ‘Maccanomics’ article, which tackles the current malaise affecting the global economy and examines why the large-scale ‘money printing’ by the world’s central banks isn’t working.  Enjoy!

I can handle the despair…it’s the hope that I can’t deal with!”

(John Cleese on the subject of the English football team…..or maybe it was monetary policy? )

Fear is again flooding through financial markets, as well it might.

Barring some fortuitous intervention from above, the developed world will soon be flirting with another recession, maybe as early as the end of the year. Moreover, there is little evidence of a convincing path for resuming growth quickly thereafter.

There is some good news. US housing has probably bottomed and residential construction should add to GDP next year. But absence of demand is the overriding problem everywhere. Aggressive fiscal tightening is now underway in Europe and will on current plans be pursued there for some years. In parallel, budget cuts and tax increases are about to be imposed in the USA unless the new Congress can agree otherwise. China and the other emerging markets appear to have neither the will nor the means to do more than keep their own ships of state steady.

There are solutions, on paper at least. The USA could safely borrow more today if it could articulate a credible plan for reducing its fiscal deficit over coming decades. But politics means it cannot do so now and is unlikely to be able to do so even after this November’s elections. Germany too could borrow more-but history and political constraints mean that it will not. Japan is at the end of its fiscal rope, with an aging population and a shrinking domestic savings pool from which to fund its deficits, so it finds itself in a tightening noose. Its net public debt burden, at 113% of GDP, is rivaled only by Italy amongst the large economies. To put this in an historical context, Japan’s net public debt was 11.5% of GDP in 1991.

A gentle slide back into anemic growth is probably the best that can be hoped for. In the Euro-zone, Spain and Italy have financing problems which appear to be beyond the capabilities of their political systems to cure. Italy’s cost competitiveness now sits at a disadvantage of about 38% to Germany’s and Spain’s at about 28%. Italy’s ability to achieve the necessary rebalancing by “internal devaluation” (wage reductions and productivity improvements) seems fanciful and at best would lock the Italian people into a decade of misery. Far more likely is an Italian political revolt and Euro-zone exit.

Despite countless Euro summits and many declarations that the zone’s problems have been solved, current bond yields tell a different story. Yields for both Spain and Italy in are in the 6-7% range and are unaffordable if sustained. Citibank (Willem Buiter), recently speculated that Spain will have to submit to a Troika program (aka receivership) later this year, and Italy next year. No-one is scoffing at this outlook.

In truth the world is probably in worse shape than it was immediately post Lehman because since then nothing of substance has been achieved in terms of policy reform, and meanwhile debt has increased everywhere. The long term sustainability of the US fiscal deficit remains unaddressed, as it does in Japan. In Europe, no one can explain how a common currency and monetary policy can work in the absence of an (unwanted) fiscal union, and in China no progress has been made rebalancing the economy away from fixed investment.

Caught in a pincer between political paralysis and their inflation and employment mandates, central banks have flooded the world with ultra cheap money. Bond yields now sit at an astonishing 1.49%pa for US 10 year Treasuries, 1.26%pa for German bunds and .80%pa for JGB’s. Bond investors will likely receive negative real yields on their money for the next 10 years simply for the privilege of having their capital returned “intact”

How long they will tolerate this treatment is an open question.

The world’s banking system is now awash with cash after the central banks of the USA, Japan, the UK and Euro-zone have pursued monetary easing strategies under an overwhelming array of acronyms including the Fed’s  ZIRP,MBS, QE and Twist programs and the ECB’s SMP and LTRO. Corporate Treasurers, wary of the bubble in bond pricing, have also fled to cash despite the zero yields on offer.

But all this has been to little avail. Trillions of dollars of dormant money now sit in the banking systems of the developed world doing nothing, whilst economies remain in chains with growth rates too low to allow debt to be paid down swiftly or to support jobs growth. In the USA, unemployment remains stuck at 8.2%:

Youth unemployment is particularly alarming. Approximately 24% of the 16 to 19 year olds in the US labor force are unemployed and, without any work experience since graduation, face the risk of becoming unemployable for life. In Southern Europe the problem is far worse with youth unemployment close to 50% in Spain and 36% in Italy.

As the above chart from Calculated Risk illustrates, something very different is going on here relative to previous recessions.

What is different is that monetary policy has reached its limits. It can do no more-and possibly may now be doing harm.

The Limits of Monetary Policy

In a normal business cycle recession lowering the cost of money reboots demand. About that there is no doubt as the chart attests. So why hasn’t it worked in this recession? The superficial answer is that “there is just too much debt”. The pessimists rightly point out that total debt levels today (sovereign, corporate and household) are actually higher than when the crisis hit in 2008 (340% of GDP versus 332% of GDP according to Jamil Baz of Man Group).

But lurking behind the bushes are some more fundamental problems which impede the effectiveness of ultra cheap money:

It’s Just a Wealth Transfer Pure and Simple

Much is made of how cheaper credit has improved the position of over- indebted households, and rightly so. But a lot less is heard about the cost to savers who now see their funds yielding a pittance. In this respect, ultra cheap money is just a tax which transfers wealth from the prudent who have worked and saved, to the profligate who have over- borrowed.

It normally works because the propensity of the beneficiaries of cheap money to spend some of their extra disposable income exceeds the propensity of the savers to cut back on their spending. Why do savers keep spending? Probably because they see the whole process as temporary, and a price worth paying for a recovery. But what happens when the years tick over and the economy doesn’t fire? And then to add to the pain the Federal Reserve says that low rates will be needed for several more years?

The answer is that the savers cut back on spending. They also start to get angry about the wealth confiscation being imposed upon them.

That is where we are now. Ultra cheap money is burning itself out as an economic accelerant, and the political temperature is rising as savers ask where the Federal Reserve and other central banks obtained the authority to confiscate and redistribute citizen’s wealth. To that question, there is no ready answer.

It Discourages Investment

Imagine you the CFO if a Fortune 500 company and that you have a new project in the pipeline with a 15 year life which awaits your approval. It appears attractive but you are struggling with a number of fundamental questions.

You need to know your company’s cost of capital over the life of the investment. How to find out? Well for starters the current “risk free rate” of 1.47% doesn’t look right and you know that rate is being manipulated by the Fed. So that’s a dead end.

What about your equity risk premium? Well in theory that can be calculated from share prices but you know that they are being held artificially high by Fed policy also. So no luck there either.

What about your customer’s spending power? How will it evolve over the next decade or two? You know new taxes will be required-but what sort and when? What will the impact be on spending patterns? And what about corporate taxes? No, sorry-no answers are available here.

You get my point. Understandably most CFOs just say, “Enough- my company should stay liquid until all this fog clears.”

But it gets worse. If your company or public sector body has a defined benefit pension plan then you are likely to have been using a 7% pa future earnings assumption to calculate your entity’s pension liability. But if Treasuries are yielding only 1.5%, and the outlook is for nominal GDP growth of 2-3% for a long time, hasn’t your pension plan (and a lot of others) got a major problem on its hands?  Yes indeed.

It Creates Bubbles

As central banks have pumped their financial systems full of free money much of it has flooded into assets which offer portfolio diversification, inflation risk protection and speculative upside. The favorites have been oil, precious metals, traded commodities like copper and the high yield currencies of the commodity producers like Brazil, Australia and New Zealand.

In parallel, funds have flooded into “safe haven” bonds (US Treasuries, German Bunds and the Swiss Franc) from investors who fear a global financial collapse.

The immediate impacts of this asset switch have been negative in terms of job creation (none whatsoever), and diminished household incomes which have been eroded by elevated prices for gasoline and other commodities.  Beyond these immediate negatives lies the prospect of a value implosion when these inflated prices correct themselves.

Please ask yourself why the surplus countries of the world should continue indefinitely to fund deficit countries’ balance sheets at negative real yields? I have no idea, do you?

If US Treasury yields normalize at around the 4% level then investors buying at current levels will see at least half their capital destroyed. That is a potentially a bigger bust than US housing.

The Inflation Risk

No-one disputes that if the vast sums now sitting idle in the banking system were to move into circulation, we would have a serious inflation problem. But in relation to this risk central banks (primarily the Federal Reserve) have said “don’t worry- we can stop the train before it runs out of control.”  We can start offering interest on bank funds on deposit with us to retain those funds within the banking system and we have an array of other tools as well.

The problem here is that this is all uncharted territory. Money creation hasn’t been done on this scale before and there are plenty of skeptics who see an inflationary outbreak as a serious risk either because of a miscalculation by central banks, or a deliberate policy of using inflation to “eliminate” some debt.

And if you see inflation as a risk then off you go and buy commodities or other real assets pumping the price balloon full of yet more air. And so around the bubble circuit we go.

All of these costs and risks are well understood by central bankers, at least in principle[1]. But they are trapped by their mandates and by their past actions. Once started, the free money game has to be kept going-like a Ponzi scheme. If asset prices start to wilt then confidence, and any hope of recovery, is put at risk. Only more free money can keep the balloon afloat and Wall Street knows this very well.

There are rocks, and there are hard places.

Where To From Here?

It is possible that the banks’ ultra cheap money policy may yet work. But the evidence supporting that outcome is weak and we should be prepared for failure, not because of errors by central banks but because they are being asked to do too much.

The developed world is in a bind; free money without parallel policy reforms isn’t working and is losing whatever power it has by the day. But the political will to pursue fundamental reforms is absent. Until one of those conditions changes our economies will remain frozen-unable to grow by reason of too much debt and too much uncertainty regarding future policy, but insulated from total collapse by free money.

In pursuing cheap money policies the main central banks handed politicians and policymakers a lifeline which provided time and space to deal with underlying structural problems. But universally (with the honorable exception of the UK), politicians have failed to grasp the lifeline because they have feared the consequences of telling their electorates the truth.

That truth has three core elements: the first is that we have a ten year problem on our hands (the unpicking and re-stitching of the Euro-zone will alone take five years at best); the second is that some combination of higher taxes and lower benefits is going to be required everywhere with a resultant fall in living standards; and the third is that a radical restructuring of global debt through debt to equity conversions and negotiated debt releases may ultimately be needed.

None of this is what electorates want to hear, or politicians have the courage to say.

Fund manager Hugh Hendry (of Eclectica) recently made the comment that the politicians of the developed world fully understand the excess debt problem and are simply frozen in terror; He said of our politicians, “the truth is that the scale and magnitude of the problem is larger than their ability to respond-and it terrifies them” Maybe. Or is the problem that over the last generation our democracies have morphed into instruments incapable of medium-term perspectives and in which the main parties, obsessed with preserving their “brand”, hold to positions that cannot accommodate cooperation and compromise?

Make no mistake about it-democracy is now on trial and the current approach is not going to cut the mustard.

We had better get it right quickly.


[1] See El-Erian,” Evolution, Impact and Limitations of Unusual Central Bank Activism”, Homer Jones Memorial Lecture, Reserve Bank of St Louis, April 2012.

Unconventional Economist


  1. Good Lord!

    “Much is made of how cheaper credit has improved the position of over- indebted households, and rightly so. But a lot less is heard about the cost to savers who now see their funds yielding a pittance. In this respect, ultra cheap money is just a tax which transfers wealth from the prudent who have worked and saved, to the profligate who have over- borrowed.”

    Surely HnH will take him to task on this outlandish absolutely incorrect statement!!!!!!!!!

  2. ‘The answer is that the savers cut back on spending. They also start to get angry about the wealth confiscation being imposed upon them.’
    He is right, this saver is extremely pissed off with the steady erosion of his wealth…and the burden of all the changes in taxation and superannuation.

    • Did the yield tables last night for MI across the major banks/instos for TD’s/savings accounts etc..

      its really really slipping…hard to find good solid yields now….that beat real purchasing power.

      All well and good that CPI says inflation is muted/zero – but when healthcare costs (i.e the elderly) and education costs (i.e the indebted Gen X mortgage debt slaves) are rising 6% y-o-y it matters little if you can buy a TV for same price last year.

      This trend is probably pushing folks to equities, where dividend yields for the index are nearly twice that of bonds…

      But again, only some good companies pay a dividend yield better than a TD – and that spread (2% for most) is not enough for most to take on the extra risk.

      Great article btw!

      • Absolutely Prince!
        As Rumples said the fact that we are depending on a continuously rising A$ for our low inflation ought have us all worried….but it doesn’t.

      • yep pretty much. its all defensives now. offshore more attractive too with dollar strong and more variety as we have previously discussed.

      • Would dearly love schools to smell the coffee and slow fee increases! Not holding my breath.

    • ‘The answer is that the savers cut back on spending. They also start to get angry about the wealth confiscation being imposed upon them.’

      Agreed with you Russell, and I think lots of savers are angry with current situation and trying to get even with whatever means possible. One thing they can and actually have done is stop spending as mentioned in the article either to preserve their wealth or to get back to the screwed economy and system which have f***ed them. No more spending and no more GST income to the stupid politicians.

      • It’s an interesting point. Not spending has become most satisfying both from a saving perspective but also from the perspective that it registers a protest against the way the situation is being handled by politicians and companies.

        All we seem to hear is that if we all start spending again it will be all ok, that we need to get debt rolling again – and most people are saying that wasn’t a very nice place to be in the first place. Previously we were rewarding debt speculators and doing nothing for legitimate industry and workers why the hell would we want to go back there?

        • I guess either consciously or probably not so, the savers have tried to get back to the current political and economical system by not spending and trying their best not to pay any tax (including GST). I suspect that’s also one of the “underlying” reason Australians like to have overseas holiday and buy online from overseas websites i.e. saving money and not paying GST.

  3. Thanks UE….Great article!!!
    Macca will get a place alongside Marc Faber!!!!

    I would suggest the only thing he is missing that is of significance is “The End of Cheap China”
    When this is combined with the other problems he outlines then we really have the recipe for disaster.

  4. I reckon Austrian School economists would agree with most of that. The Keynesians, on the other hand….

    • You need to get your Economics schools 101 right.

      Free money isn’t Keynesian. It is Chicago school/monetarism – Milton Friedman was the original proponent of the “Helicopter drop”.

      But I don’t expect anything better from Randian Luddites that can’t tell the difference between fiscal policy and monetary policy.

      • Rumplestatskin

        Yep, Keynes wanted governments to spend on projects of general benefit to the population (e.g. infrastructure), not simply give money away.

        • Keynes had some pretty strong opinions on Govt debt as well. There were clear caveats in his General Theory. But , like all good politicians, they only promote the bits they like.

          Bottom Line: It’s best to not have public Debt. Measuring ourselves in this regard against economies addicted to Debt ( UK, US, Europe ) is a dumb and dangerous metric.

        • Worse still most countries have just been giving the free money directly to banks.
          Even free money to the people is better than that.
          But actually spending money on useful things would be better.

        • “If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coal mines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note bearing territory) there need be no more unemployment and, with the help of repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is.”

          ‘General Theory’ John Maynard Keynes 1936 ed bk 3 ch 10

          • Thanks for the quote CB.

            If the Treasury were to fill old bottles

            Note he says Treasury, NOT central bank. i.e fiscal policy.

            laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note bearing territory)

            Lo.. and behold. It isn’t “free money” after all. i.e. there is labour (digging up) and capital (lease) involved.

      • “Free money isn’t Keynesian.”

        Noted Keynesian, Paul Krugman thinks so:

        “And he [Keynes] called for active government intervention — printing more money and, if necessary, spending heavily on public works — to fight unemployment during slumps.”

        Let’s not forget that Keynes’ definition of “public works” included burying money in bottles and digging them up again.

        • 1. To restate the obvious – you don’t seem to know the difference between monetary policy and fiscal policy.

          2. Since when did Paul Krugman have the last word on what is Keynesian? Shouldn’t you be looking at Keynes work and quoting him directly?

          3. burying money in bottles and digging them up again – Again, can you enlighten us on how that is “Free money”? (unless you are proponent of “free labour”, i.e. slavery).

          • “Free money” is Keynesian in the sense that (a) leading Keynesians support it and (b) it is a natural consequence of their economics.

            Keynesians believe that govts should run large deficits during a recession to fund public works (fiscal policy), but deficits have to be financed. Since raising taxes to finance deficits during a recession will make things worse (austerity) the govt needs to borrow the money. This is where fiscal and monetary policy intersect since much of the financing is done by the central bank.

            In the US, almost half of US treasury securities (~$5 trn) is held by the Federal Reserve.

          • Lot of words there. But none of them address the original question of whether John Maynard Keynes proposed/supported “Free money” or “monetary easing”. Did Keynes advocate that Central banks should buy government debt. i.e. monetize the debt ?

            And you have failed to address any of the 3 points I have highlighted.

        • From what I’ve read, Paul Krugman is either neo-classical or monetarist not Keynesian. Just because someone claims to be something, in this case Keynesian, that doesn’t necessarily make them so.

  5. You’re a minority Russell…don’t expect change. I THINK it will just get worse. Inflation, as suggested by Macca, is going to be allowed to run under the false notion that it reduces debt…It DOESN’T!! Never has in my lifetime anyway. Hudson et al are wrong.

    The our debts are so high you could never raise interest rates high enough to kill inflation. In any case our serious inflation will not be able to be killed with interest rates.

    As most opine we will probably see some decline in asset values which MIGHT give the savers a window. I doubt if most of us are sufficiently nimble and skilled timing wise to get this right.

    • Jumping jack flash

      What is savings in a debt based economy? It is simply unspent debt that has been hoarded?

      Consider as debt is repaid, shouldn’t the economy also reabsorb the savings that are hoarded debt? Or am I looking at it incorrectly?

      Can we really turn debt into savings?

      It is confusing because there is absolutely no way to know if the dollar you’ve just been paid has been earned through hard work creating a product and selling it to someone who buys it with their wages created from performing the same activities, or created with a swipe of a credit card or from cashing in on equitymate, etc.

    • russellsmith55

      Russell isn’t a minority… there’s at least two Russells posting on this forum! The number of flawses have seen no growth since I joined however.

  6. If most of the big and smart money is in bonds – then surely deflation is a great outcome for these guys? Is it only the political unpalatability of this that stops it and keeps the central banks on the print?

    Since when did the bond holders not get what they want?

  7. “..over the last generation our democracies have morphed into instruments incapable of medium-term perspectives..”. And here’s the nub of the problem. The last generation, the wealth hoarders, doesn’t have a medium term….anything! They’re into the final phase, and anything beyond the next few years won’t matter to them. Monetary policy; macroeconomics; universal string theory…you name it…it doesn’t matter… when your in a pine box in the ground. It only matters what happens until then….

    • russellsmith55

      Ha never thought about it that way. One explanation of why people seem to get more conservative as they get older… I vow to remain progressive even when I become an old timer!

      • I love how the Left use “progressive” like a little chest badge. I don’t know who coined the phrase but he sure had a warped sense of humour.

    • The problem is also not helped by the apathy of younger generations towards politics. You can see some Gen X started to take the CEO role in corporate life, even some genius Gen Y may strike it big with their own companies / ventures.

      However, it is really hard to see the younger generations in the political party though they should do it to ensure that they’re not totally screwed by the inter-generational warfare started by the Boomer MPs. Niall Ferguson mentioned about this in his recent speech:

      • So the problem of younger generations being victimised is worsened by their resignation to being victimised by those at the helm?

        Perhaps my X/Y peers and I are content to tend to their more immediate needs (productive employment, paying down debt) while giving these rent-seeking future stealers hopefully enough financial rope to hang themselves. I read somewhere that the meek shall inherit the Earth, it’s a tough idea to rule out.

        Personally I think that if there’s only thing that would be of benefit, it would be education by those who understand what actually seems to be going on here. Sadly the politico-housing-financial complex effectively controls 99.9% of the media, and no one I know reads Matt Taibbi in Rolling Stone.

  8. Hugh PavletichMEMBER

    Leith and Macca – many thanks for an excellent article.

    I do wonder though how this excess money printing stacks up against the total value of bubble wealth destruction, as housing bubbles are collapsing.

    My understnding is that there has been something in the order of $US7 trillion of bubble value wiped out of US housing – the equivilent of 50% of its GDP (our Aust and NZ numbers are a lot worse).

    Housing bubbles are collapsing as well elsewhere – such as Spain, France and China – and will do as well in Australia, New Zealand and other markets too.

    And as these housing bubbles collapse, Governments fiscal positions deteriorate as well. The bubbles allowed expenditure to get out of control while they were inflting. The reverse happens when they bubbles defate, requiruing them to borrow and increase debt.

    I do wonder if this money printing is just small change, when compared with the comprehensive costs to both households and Governments, as these unnecessary housing bubbles deflate.

    • When excess credit money (created by the banks loans)flood the economy they produce an asset bubble. When this asset bubble bursts, the banks are in trouble and all their claims against their debtors are transformed in base money (by FED direct printing) in order to repair their balance sheets. In this way what once has been considered households’ wealth (houses, savings, superannuation investments etc.) disappear, because of the bubble burst and value assets collapse. But by printing money and giving them to the banks, the households’ lost wealth is resurrected again, but this time it is reallocated in a few hands – those of the bankers, not the households. With repeating money printing, this wealth is not only resurrected and “reallocated” to the banks, but it start its own growth by sucking the household wealth remains Left savings) and incomes through hidden inflation. This must be criminal in a genuine democratic system.

      • +1 The best comment I’ve seen thus far telling us the obvious.

        I never understood why we have a lot of these economic schools and their equations – in the end common sense thinking seems to be the school that won out. They seem to always paper over your fact and come up with what seems preposterous to the average person. i.e CAD’s don’t matter, debt doesn’t matter, etc. Its really tempting to believe in conspiracy here and say that most economic dogma is simply propaganda by the people doing the robbing. How often do we hear that the man on the street these days was right and the economists generally were wrong?

        • Thanks AK, I believe that getting the right sense depends of what one had read and learned from history and the best books available, not from modern economic ideology. The truth is always very inconvenient that is why it must be masked with some kind of “professional” clouds like technical analysis, complicated financial instruments, which none of the ordinary people and retail investors understands, so that everything occurs in a black box for the non-chosen ones. In that way no one has the chance to get to the bottom and to the main purpose of all those complex but useless and most of the time harmful, from economic and social point of view, financial exercises.

        • “Its really tempting to believe in conspiracy here and say that most economic dogma is simply propaganda by the people doing the robbing”

          If one takes the time to dig deep enough into the backgrounds of many of the leading individuals, schools, and proponents of modern economic theories, the ‘temptation’ you speak of becomes increasingly irresistible.

        • “Its really tempting to believe in conspiracy here and say that most economic dogma is simply propaganda by the people doing the robbing.”


      • Sums it up nicely really.
        Governments gave their money printing rights to banks and mysteriously they abused that privilege to get rich.

      • There is a good argument for governments retaining equity/nationalising banks when they need to be bailed out in this way. That way at least taxpayers/households aren’t footing the bill for irresponsible lending.

        The bank could then be reprivatised down the track once everything starts to settle down.

        Of course this would all be irrelevant if banks were just told to lend responsibly and have a stronger equity position in the first place.

          • ASIC already do this to an extent. NCCP was all about responsible lending (although they could have done it without the ridiculous paperwork requirements).

          • Indeed. But to be clear – what constitutes responsible lending on the part of privately owned banks should be determined by government regulation enforced through government agencies, and not via a mechanism of self-regulation with the presumption that enforcement will occur via rational participants in a free market, effectively punishing private banks seen to be lending irresponsibly ?

          • A good question. I’ll be honest, I just don’t know the best answer as I really haven’t spent all that much time considering the possibilities.

            Probably a combination of government and private sector regulation would be the answer.

            Although personally I would consider responsible lending as being mortage repayments of not more than 50% of disposable income over the henderson poverty line for mortgages (assuming a rate higher than the actual rate). But I’m sure there are plenty of other ideas.

          • FWIW, I’d really like to see a cogent and compelling argument made for why the charging of interest *at all* on loans is still permitted by human society. Especially in an age when all ‘money’ is created at the click of a mouse button and a tap on a keyboard.

            The root issue is ‘money’; what it actually is, how it is created/issued, and who benefits simply from its creation/issuance.

          • MattR, I am pleasantly surprised to find out that you support increased government regulations such as NCCP!!

            BTW, the paperwork is probably needed as an audit trail, in case evidence is needed in a court case.

        • Yes I think, as Lori suggests above is the problem. As we’ve seen in Europe, until very recently ( ) the plan has been to re-capitalise the banks via central bank operations, keeping banks alive at all costs yet completely ignoring the fact that the private sector is buried in debts and sinking.

          QE is a banking system ->central bank operation, the “money” never leaves the banking system. I therefore have a bit of an issue with the term ‘free money’ because it conjures up the idea that households are being given a cheque for $5000 that they never have to pay back.

          This certainly is not what is happening at all. The European LTRO program added nearly a trillion euro in bank reserves, yet the wealth of the private sector in the European periphery continues to collapse at a rapid pace.

          • “I therefore have a bit of an issue with the term ‘free money’ because it conjures up the idea that households are being given a cheque for $5000 that they never have to pay back.This certainly is not what is happening at all.”

            Exactly, and why is that? Because none of the modern monetary theories makes any difference between the households and the banks. They pretend that the money FED gives to the banks always flow to the household. But even if they flew to the public, it would be only in the form of CREDIT, not income, so it wouldn’t be able to increase the effective demand unless further increasing households’ debt. That is why FED will never solve the debt crisis, because it aim isn’t to help the households and the small businesses, but to resurrect and to consolidated the wealth of the financial sector. They can’t be so stupid not to see how futile are there QE1,2 and maybe 3 regarding employment, demand and organic growth. Or is they are really so stupid, then the world is in big sh..t.

          • Hugh PavletichMEMBER

            Many thanks for all your comments.

            As a property guy I tend to compartmentalize the finance aspect of housing bubbles in to – (a) equity (b) bubble equity and (c) mortgage debt.

            As bubbles top out then crash – as volumes and prices fall away, it is the “vaporization of (b) bubble equity that particularly interests me. And particularly, how it drys up liquidity in an economy….creating massive destruction across the board in the process.

            Hugh Pavletich

  9. +10 Thank you. Brilliant analysis and exactly to the point – “It’s Just a Wealth Transfer Pure and Simple”. At last the deeper digging reveals the real face of the financial industry and what is all about. It is about confiscation and all will end ugly. Most of the people still live in dreams and don’t realize how big is this time, it is like never before in history. The great illusion of 20th century is over. Does someone have any solution to this deep systemic problem? No one, because the solution requires extreme measures and fundamental changes and there are no enough intelligent politicians or brave leaders to get this gigantic job done. We are stuck in slow decay and maybe at some stage the last resort will be a war, as usual, because fighting for our own life always gives more sense than anything else.

    • “At last the deeper digging reveals the real face of the financial industry and what is all about. It is about confiscation…”


      No more need be said.

    • harmin…correct…it’s all central banks including the RBA. As analysed by Rumples the RBA has been running a policy of negative RAT rates almost continuously since the bears were bad.

  10. What governments need to do is to actually spend new money directly into the economy via infrastructure investment, thus directly stimulating the economy.

    To put it into medical metaphor, applying defibrillation, which works in normal situations, they need open heart massage to get the system up and running again. This is an obvious and workable solution yet policymakers are, as the article implies, literally petrified. They have been programmed for so long to understand the workings of the monetary system in only one way only: interest rates up or down and cannot really fathom how to respond to a debt induced economic collapse (never mind that this has been happening regularly for the last 300 years).

    It’s time for some Monetary Dialysis.

    • “new money” doesnt exist. It’s just more debt.

      The dilemma as I see it is that in the US at least, it has taken all the Fed’s considerable resources to just prop up a very hollowed out financial/banking system. To keep the facades intact so Joe Sixpack doesn’t panic and do a runner (to the Bank!). Precious little is left for “stimulation” if your using everything you can print on holding the rickety construct in place as well as funding a global Military behemoth.

      Few options for escaping this dillemma are available in the current system. Spend and hope was one of them, but it’s going nowhere fast. Luckily we have China at our back- for now.

      • Yep…you inject more new money into this economy it finishes up in the Current Account Deficit which means more debt or more asset sales to foreign buyers.
        Nothing comes from nothing!

        • Flawse.

          Please explain why you think new money automatically ends up in the current account deficit.

      • GSM…..”new money” doesn’t exist. It’s just more debt”

        Could you please explain this comment, as it doesn’t make any sense.

        • Raf,
          If you were referring to Oz as I was, I meant that with over $150Bill and counting of existing Govt Debt, any “new money” released into our economy must come from raising new bebt. Govt is living way beyond it’s means ( revenues).

          It’s also been tried- the BER construct fest. Essentially the Australian version of the US $500.00 toilet seat fiasco. It didn’t work. It bred massive taxpayers funded waste and has not generated the ongoing construction catalyst Keynseians dreamed of.

          What’s missing are CONFIDENCE and CLARITY.

          • Correct me if I’m wrong, but a sovereign with their own currency can “print” new money into existence without the need to raise new debt. This is dilutive (and all the fallout there unto), of course, but doesn’t require new debt.

            …or am I missing something?

    • russellsmith55

      I think the last thing Australia should do right now is anything that would increase its foreign debts. We might end up with a gigantic hard-china landing hole in the budget and only atrophied industries to fall back on.

      Or the government could try to borrow it all locally and consequentially drive up business lending rates in an already low confidence and fragile environment.

      Have to agree with GSM, not really anything we can do other than hold our breath and hope for the best. Policy based paths out of this mess just aren’t available. The ‘problem can’ is becoming too big to kick any further down the road. There is just way too much debt out there to ever get repaid or inflated away.

  11. This situation has me quite worried along with the rest of you. Never have I seen the economic and future social issues facing both our nation and this world laid out so well.

    “..over the last generation our democracies have morphed into instruments incapable of medium-term perspectives..”.

    That really sums it up. The current economic woes could be solved through good and courageous government from either the right, left of centre just as long as their number 1 priority was the national interest. But that isnt going to happen politicians are far too afraid of damaging their brand as the article says.

    I too applaud the Cameron government in the UK for telling it like it is even during the election campaign, some of his policies may not be popular or even any good but he is genuinely trying to act in the national interest.

    “Make no mistake about it-democracy is now on trial and the current approach is not going to cut the mustard.

    We had better get it right quickly.”

    This is really the crux of the article. If we dont fix these problems soon democracy as we know will cease to exist in the nations hardest hit until only a few bastions of democracy remain like in the mid to late 1930’s.

    Far too many people believe that it will not come to that, that we are somehow more evolved than we were in the 1930’s or earlier, but that simply isnt the case. If only the dictator will do whats right for the country people will back the dictator, it really is that simple.

    Before some exteme party gets there first I shall be the first to say Macrobusiness for PM, Viva la revolution 🙂

    • Good one Tarric. Maybe we have progressed here. I once copped a gobful for suggesting a bad outcome like that.

      The Germans cop a lot of flak for their current stance. Their great fear is what is described here. They’ve seen it happen before

    • The big problem is that for the politicians it is impossible to conduct strong national policy. They are struggling between the national interest of the households and small businesses from one side and the global capital interests of the former national corporations, which are no longer national, especially the outsourced ones, from the other. So which interest is more important for the politicians – the national one or the corporate ones? The world needs more cooperation between the governments otherwise this crisis can’t be solved without some kind of strong protectionism, which is the only really national policy tool. Any other measure will be destructive for the national households and ordinary people, because it will work for the global corporations. It is a chatch22.

      • I’m not so sure. Gov’ts have done enough damage. They have solved nothing. Vested partisan and other interests see to that. Manage the process yes, solve it no way.

        As a starting point, bad debts have to be recognised and ABS’s, CDS’s, swaps etc and their multi faceted vehicles need to be marked to market. Not the current “marked to make believe”. Debt needs to be flushed out into the light and solvency of Banks and Sovereigns re-assessed. This whole debt and asset related situation needs to be reduced to a real and true Accountancy problem of assets and liabilities. As a starting point just to regain confidence.

        Until the full extent of the Debt and “asset” related damage is known, the current damaging pantomime that is the world economy will continue. Until something breaks. Then, it may be so much worse that 2008.

        • How do you imagine this can occur when all big banks are interdependent and interrelated? How can this happen just in one country without the cooperation of the others?

          • It’s not about countries or Govt’s. It’s about the derivative instruments all banks (not much in Australia thankfully) held back in 2008 and beyond that became worthless virtually overnight.

            They even changed accounting laws for valueing these dodgy derivatives in the US in 2009 ,just to paper over the immense financial crater left behind in the US Banking system when these so called “assets” – apon which all lending and solvency computations are based – became essentially worthless/illiquid. That is the suffering we see continueing until today.

          • Lori,
            I dont think it can happen in just one country. Banking rules tend to be global. Set in large part by the B.I.S. Accountancy rules however are set by each sovereign although with some general commonality.

            To my mind the elephant in the room is the US accounting code FASB157. It allows US Banks (more than 30% approx of the global financial system) to lie through their teeth about the value of their assets – with impunity.

            This valuation governs their share price, their ability to loan, solvency ratios etc. This valuation is all that is holding up the US financial system. Based on a fallacy.

  12. I can’t remember where it is but a few years ago Steve Ballmer, this is after the GFC, wrote a great article about the GFC debt implosion and how economic activity and growth (if any)would be so different going forward from that point.
    Essentially his message was that massive amounts of consumed debt had called forward years, maybe decades, of consumer demand. To the point where credit saturation and risk had combined to now (then) dramatically diminish credit demand and credit supply for many years ahead. (The new “normal”). It struck me because this was very early in the rubble of the GFC , around lat 2008’ish I think. The world economy was geared up for say 100 gazillion units of annual production, but for the foreseeable future there was only demand for 80 gazillion units annually. A LOT of capacity facing much lower demand.
    With growth in the global economy having been driven by growth of credit , there was a huge demand gap to be filled if private consumption was headed to the tank as he foresaw. Enter Gov’ts, Bailouts, Nationalisations, all manner of Public spending, QE 1 and 2 + Twist etc etc. Markets have been propped up, kind of by TPTB. The Real economy ? Well patchwork in Oz. Bedlam , collapsed or dead elsewhere. Consumers don’t buy into the faked numbers and Gov’ts are fast running out of ammo.
    And still, here we are. It’s a waiting game alright. I’m thinking back to the Roubini post. That’s why I don’t dismiss him. And this great article ( Thanks UE!) compliments NR’s position. Timing is everything!

  13. Great article.

    Its quite interesting to look at the chart of UE and lack of rebound… the only previous recession comparable to the current one in terms of slowness of employment creation is 2001… well, that situation was turned around by Greenspan and his housing bubble. That medicine has been used; QE has clearly not been effective, what will turn this round?

    Nod also to the point on pensions. To me, this is vastly under-emphasised by most commentators. The truth is that the general populace in most developed countries know that their pensions are screwed and this is a big reason why consumption will have to be much lower for a seriously long time.

  14. I can’t remember. Is this all a failure of free markets, or a failure to make markets freer ?

    And what of the historical geo-political antecedents that brought us here ?

    Where is religious faith in all of this ? Does it matter ? Did it ever ?

    Or is this just the irresistible force of base human nature exhibiting its fulsome, instinctive expression, regardless of the geo-political/economic context ?

    What happens when we all start saving, reduce consumption, pass appliances, furniture and cars down through generations ? Is Germany an economic powerhouse when nobody is buying its automobiles and ovens ? How big does China’s surplus look when we realise we don’t need half of the superficial junk produced there, and act accordingly ? How should its people behave as their own standard of living drops ? How does this tip the geo-political balance ? Who has the most to lose ?

    What period in history have trading nations all run surpluses ? All existed free of debt ?

    To which point in time must we travel to find these answers ?

    How long can we hold back a tide of economic refugees in a world of globalised and de-regulated labor ?

    How do you keep ‘em down on the farm once they’ve seen Paree ?

    Can I end this post without another question ?

    • “I can’t remember. Is this all a failure of free markets, or a failure to make markets freer ? And what of the historical geo-political antecedents that brought us here ?”

      Have you heard of the evolutionary principle: Thesis – Antithesis – Synthesis.

      The free market competition(the antithesis) evolved from the middle age monopoly (the thesis). The next natural stage of market competition development is their Synthesis, which means global market competition between big national monopolies. At this global stage for the ordinary consumers and households the national market players are squeezed by the global monopolies and the confusion regarding the national policy is complete.

      • Yes, this is the way I see it. The greedy rich/monopolists dominate, accumulating wealth at the expense of the poor, eroding the consumer base. Just look at US labour income since the 1970’s.

        But just like the World Series of Poker the championship is over and it all has to start again from scratch when the winner has accumulated all the chips.

  15. Indeed!

    It is just a shame that those with their hands on the levers of interest rates are still yanking as hard as they can.

    The RBA struggle from month to month.

    “To yank or not to yank- that is the question”

    What the world needs is a creative process to keep people fed and clothed while the liquidation of debts proceeds.

    There is no alternative.

  16. This is an extremely good analysis.

    Current problem worsened by austerity correlated across regions. Japan had the benefit of exports to US to pull them out and even then they are still in the mire 23 years later.

    The other problem is that one man’s debt is another’s asset. So how do you improve everyone’s balance sheet position so that they have an income they can confidently spend to support economic activity and at the same time not wipe out savers who have accumulated assets? If you can’t then what policy produces least hurt?

    For example high inflation would redress income/capital balance as it did in the 70s but impact on savers was brutal, and high interest rates hurt borrowers, and economic activity really didnt pick up until the 80s. High inflation also leads to feedback effects that concentrate the pain on those least able to increase their relative nominal incomes – not nice really.

    The other problem with ultra-easy money is that “good” credits like Germany can borrow very long at very low rates even where they dont need the money … but how do you earn on it? And if you can’t why borrow all the extra that the central bankers are shoving out? Never thought I would see the day where the developed world’s hunger for stuff and debt to pay for it is satisfied – maybe we might get there. Have a lot more sympathy now for the poor sods in the 1930’s trying to work out how to solve the Great Depression without an adequate economic framework.

    • No. One man’s debt is another banks asset. And we must be very clear on this lest we be lulled into supporting an industry that now leaches 12% of our GDP in Australia alone.

      Defaulting on loans that cannot be repaid will remove bank assets. Not the assets of Joe Blow.

      Credit creation is endogenous and is not dictated by central banks. Loans create deposits, not the other way round. This means when credit is growing (or booming as it were) we have an increase to aggregate demand. When credit is contracting, we have a decrease to aggregate demand.

      Endogenous credit creation (the role of banks) is successful in creating lasting economic growth if it preceeds an increase in exergy (energy or productivity gains). This was easy in the post war era, as big gains in fossil fuel production, electricity productivity and manufacturing have been made.

      Can they be made again? Will we make the necessary productivity gains to even maintain current economic production as production of fossil fuel energy sources stall?

      No. If the rise and fall of energy prices is any indication, we will only make the transition by crushing demand (and hence reducing credit and destroying money). Debt deflation is here to stay.

  17. What is particularly interesting in this discussion is the consensus the agreement across myriad background of the contributors.

    And I know my position has been adjusted by having read discussion over the life of MB.

    This is a metric of the success of MB and thanks to Macca too.

  18. From what I am reading I get the picture of money being introduced in to the economy with it then failing to move further than the financial system. I noticed that a lot of the comments spoke about the bad habits and flaws of the banking system contributing to this. Leaving the real world chaos aside for the moment, what do you think would have happened if the banks were not bailed out in 2008? I imagine that it would have forced some changes in practice to be adopted and hopefully they would have been of long term benefit.

    • Bank bond holders would have been fried. Banks capital base would vanish and insolvency to follow. The Financial System as we know it stops.

      Yes, that would force some changes alright.

      But they (Govt and CB’s) “fixed” the problem by booting the can down the road, bailing out Banks and bringing their debts on to public books, as well as the CB’s. The US now has Zombie Banking ( the Living Dead). Demand for credit has collapsed since 2008.

      We await the next shoe to drop.

  19. Free money isn’t working? Really?

    What about all the people harping on a year ago about the super-inflation that was supposed to tear the world apart?

    Unfortunately for you money creation is endogenous (created by banks). Steve Keen has some telling plots of M1 versus M0. If M1 is not leading M0 then the correlation between the two is very weak i.e. central banks are printing with no response from normal banks.

    This makes this Macca fella as wrong as every other neoclassical economist who ignore banks and money in their models!

    He even tells the cracker of how savers must stop spending to allow borrowers to spend. This is pure WRONG. Credit that is created (destroyed) by banks increases (decreases) aggregate demand.