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Financial Crisis and the Global Future (August 2015)
As per the meme featured in the books “Satan's Plot” and “The Synth” (coming soon), global crisis seems to be imminent as we approach the final quarter of 2015. Anyone keeping their eye on the global economy for the past 7 years will have noticed the tepid recovery that the governments and central banks of the world promised but haven’t quite delivered. Quantitative easing in the USA, Japan and Europe has done little to help the “little guy”; the middle and lower classes and especially not the savers. It has made the financial system and the plutocrats very wealthy but it hasn’t made small business or industry more productive.
Too Much Debt:
So how did the world get here? The answer is quite simple: Too much debt for way too long. When governments, companies and individuals borrow money, what they are really doing is compressing the future into a single day. So if someone borrows $100K now and it takes 30 years to pay it off then they are compressing 30 years of their working life into the very moment they sign the loan application on the dotted line. That means that for the next 30 years that person will have to sacrifice a large chunk of their income leaving little or none for emergencies and basic luxuries. This puts downward pressure on future spending, essentially making it more difficult for future businesses to prosper. We haven’t seen this pressure in the past because the world has been growing exponentially for over a century (thanks to fossil energy) creating enough bounty for everyone. To continue, however, assumes infinite growth is possible; that energy, commodities, fish in the sea, food, fresh water and space will always be plentiful. Clearly these fundamentals are starting to become more difficult to secure in many places in the world.
The amount borrowed may be much more than $100K and it may not be a single loan. The dollar amount could be quite large and the number of loans significant. A loan for a house, a car and a boat may give someone everything they ever dreamed of right now but when the car finally dies, the boat sinks or the house needs repairs there is often no money left to cover the contingencies. More debt may be needed to cover these unanticipated costs which can lead to an even more precarious future. The example can be applied to companies and governments. Instead of a house the asset might be a factory or a railway. Instead of a car it might be a corporate jet or Airforce 1. Instead of a boat it might be a sales office in the middle of London or Lockheed Martin’s ill-fated F35.
Declining Spending and Government Defaults:
The solution to downward pressure on spending and growth that our institutions and governments have proffered is to just make it easier to get more debt. Encouraged by that policy governments accumulate debt in vast amounts often borrowing just to make the repayments on existing debt!! Because everyone assumes the government will always be able to pay their dues, raising money by issuing bonds (IOUs) becomes dangerously easy and leads inevitably to profligacy. This recklessness afflicts some countries more than others. The same largess happens with companies, a well worded brochure describing glorious new ventures, resources or products is enough to garner billions from willing share-holders promised unrealistic returns. For the little guy the banks hand out credit cards like they are promotional candy.
However, as we have seen, the debt spiral eventually leads to default. Greece and Puerto Rico are recent examples of mismanaged governments that have borrowed beyond their means. The unsustainable fracking ‘miracle’ in the USA has exemplified the way oil corporations have borrowed carelessly to finance a dream that was more sales-pitch than actual return. No account was ever made for a drop in oil prices from their unsustainable peak. Just like the governments and companies, “little people” also get into trouble all the time and are the bread and butter of the world’s debt-collectors and pawn-brokers.
Low Interest Rate Policies, ZIRP and Defaults:
How did debt get out of hand? It’s partly the fault of low interest rate policies of the FED and central banks around the world. By lowering the cost of borrowing (dropping interest rates) it’s difficult for investors, banks, savers, 401k and pension funds to get a good return. The desperate search by banks and cashed up investors for yield encourages the lending of more money to anyone and everyone regardless of their ability to pay. Investors buy up junk bonds from insolvent companies and governments or pour money into real-estate and stocks, driving up prices way beyond fair-value. As a consequence a lot of money found its way into shady bonds from Greece and shale-oil company stocks to name just two areas. This whole orgy of investment creates bubbles that encapsulate enormous risk. When those bubbles finally pop, as they must, part of the financial world craters leading to disasters like the subprime mortgages debacle of 2008/9.
As was explained above, at some point all borrowings have to be repaid and excessive debt at even a zero interest rate will still put permanent downward pressure on a borrowers future spending. If there is an unexpected loss of income those debts can become insurmountable and defaults occur. Those defaults can be “insured” against in some cases but if the defaults are big enough the insurer itself can fail, as was the case (in a roundabout sort of way) with AIG and Lehmen Brothers.
The Onset of Global Deflation: The Commodities Crash.
It seems likely that the world’s financial system has finally reached the point where there is so much debt that everyone is struggling to make ends meet and cannot borrow any more. In such a world there is no income available for new ventures or new purchases and the industries that service new ventures or produce goods for purchase start to wind down. When industries wind down, people lose their jobs or they get paid less. Without sufficient income people can’t afford to purchase the goods and services which sustain industry. Eventually industries that can’t afford to operate in such a dire environment go broke, which leads to even more unemployment. It can be concluded that industries are winding down because the demand for the commodities they use to make products and provide services is declining, as evidenced by the crashing commodities market.
Essentially that’s a deflationary spiral that affects everyone. If industry collapses people don’t make money and stop borrowing. Bank-profits decline and financial institutions find fewer prosperous customers to lend money to. At that point the remaining wealth turns to real-estate (tangible assets), US bonds and the stock market while real spending-inspired GDP collapses. So far, it seems, the stock market and real-estate have been able to hold all of the money that has nowhere else to live. Eventually however as signs of malaise increase confidence wanes until people get scared and rush to cash their port-folios so they might hide from global financial decline. If the rush is big enough an avalanche of losses prevail that can break whole banks.
Financial Crisis or Financial Collapse.
It seems we are now at that precipice. Lately, with commodity prices tanking, the Chinese stock market crashing and the Dow Jones dropping, it looks like the zero interest rate party is about to expire. Deflation appears to be well and truly setting in, sparking fears of imminent global financial crisis in some circles. Let’s just hope it’s not a full-fledged global financial collapse but regardless of the level of carnage it seems clear that it will take a very long time to reverse the damage that has been done.