The Big Picture: From banking crisis to sovereign debt crisis to currency crisis

This article attempts to outline all the macro forces and trends that are currently impacting the global economy and financial markets. It is only by understanding all of these forces (and the interplay between them) that investors can begin to see the inevitable path from banking crisis to sovereign debt crisis to currency crisis.

Debt Deleveraging: For around 30 years the public and private sectors increased their levels of debt. Now however, the private sector is paying down that debt. See: The debt deleveraging process has only just begun.

Quantitative Easing (QE Infinity): Quantitative Easing is designed to increase the supply of money in the economy and inflate away our debt. See: What is Quantitative Easing & why has it failed to stimulate growth?

ZIRP (zero interest rate policy): ZIRP is designed to stimulate spending, i.e. GDP. However it also creates asset bubbles and destroys wealth.

Negative real interest rates: NRIR are part of a policy of financial repression that’s designed to inflate away our debt. See Financial Repression Has Redefined Risk and Keynesianism, inflation & euthanasia of the rentier: A survival guide.

Inflation: Inflation is underreported and widely misunderstood. It is an increase in the supply of money and credit and it erodes the value of both money and debt. See: Our Broken Money – The Root Cause Of Inflation and How To Cure Inflation (if you really want to).

Rising Money Supply: Central banks like the Fed began to sharply increase the supply of money in the 1970’s. The newly created money enters circulation via fractional reserve lending and is partly responsible for the long-term decline in interest rates. See: Money supply accelerating and Examining the global crack-up boom: Part II.

Falling Money Velocity: Money velocity, i.e. the rate at which money moves through the economy,  is at the lowest level in more than 50 years and is still falling. This is naturally deflationary, but it is being countered by central bank QE. See: Chart of the week: Money velocity plunges to lowest level in more than 50 years.

Financial Repression: Financial repression is a collection of policies which include negative real interest rates, government ownership/ control of domestic banks, and forcing banks to hold government debt via reserve requirements. These policies are designed to erode the value of our debt. See: Financial repression poses a serious threat to your wealth.

Rising cost of living (CPI): Apart from a brief dip in 2008, the cost of living in the US (and UK) has been rising since the 1950’s. However the true scale of the rise is not reflected in CPI. See: The Markets vs. the Economy: Examining the Great Disconnect and Britons Cost Of Living Will Double Over The Next 10 Years.

Rising Stock Market: Equity markets in the US and UK have been in a bull market since March 2009. However, although corporate earnings have improved, the rally is largely being driven by QE from the Fed and other global central banks. See: The best way to profit from the liquidity fuelled bull market in US equities.

High Unemployment “The Jobless Recovery”: The current economic “recovery” has been called a “Jobless Recovery” since unemployment has remained high. The reason is QE cannot create true economic prosperity. See: QE can create GDP growth but not economic prosperity.

Debt Rollover: Between now and the end of 2014 the world’s top 10 debtor nations have to rollover $12.7 trillion (£8.2 trillion) in maturing sovereign debt. This has caused central banks to step in as the major buyer of these bonds. See: The choice is simple: Massive money printing or global depression and Japan: The Next Sovereign Debt Domino.

The Search For Yield: The zero interest rate environment (ZIRP) has triggered a speculative search for yield with fixed income investors forced to take greater risk. Central banks are even buying stocks. See: This will end badly but not yet.

Broken Economic Model: Our economic model is broken. We have created an economy that is deemed prosperous only when we spend ever greater amounts of money, but increased spending does not equate to a better standard of living, and therefore GDP growth and economic prosperity are not the same thing. We need to stop trying to borrow and spend our way to prosperity and begin rewarding saving and investment. See: QE can create GDP growth but not economic prosperity.

Bank Lending: Government’s, both in the UK and across the G20, are actively trying to encourage banks to make loans to households and businesses in order to stimulate economic activity. However, having been burnt so badly in the financial crisis banks are reluctant to lend. New regulation requires that banks hold greater reserves which also impacts their ability to lend. See: Osborne & King deliver another dose of Keynesian medicine.

Declining real incomes: Between 2007 and 2012 nominal wages in the UK rose by just under 10%, but the cost of living (as measured by the CPI), rose by 17%, so real incomes declined by 6.3%.

Bail-outs: Politicians and central bankers should not be using public funds to bail out failing banks and businesses. We need Joseph Schumpeter’s creative destruction not a zombie economy. See: Why we still don’t have a true economic recovery five years after the global financial crisis began.

Bail-ins: The €10 billion Cypriot bail-in is now the model that will be used to “rescue” insolvent banks in future. Following the agreement of the plan, the president of the eurogroup said the relative calm in the markets since the decision to force private investors and depositors to pay for the bailout of two large Cypriot banks, allows the Eurozone to go after private money more aggressively when banks fail in future. This bail-in model presents a real risk for depositors in other countries, not just the euro periphery, as evidenced by legislation change in the UK and Canada.

Crony Capitalism/ Corporatism: Many people attribute the global financial crisis to the failure of capitalism. However we didn’t have capitalism, we had (and still have) a form of crony capitalism/ corporatism in which governments manipulate key economic indicators (such as interest rates), and pick winners and losers by bailing out those that are “too big to fail”. By doing this western governments have socialised risk and burdened the taxpayer with toxic debt. See: Capitalism didn’t fail but it might as well have done.

Keynesian Economics: Keynesian economics is extremely seductive. By increasing government borrowing it promises to bring about economic growth and smooth out the business cycle. It is very persuasive, but government stimulus has already been tried on an unprecedented scale and it has clearly failed. The fact is Keynesian philosophy is fatally flawed. See: The flawed logic of Keynesian economics.

Erosion Of Capital: The lifeblood of a capitalist economy is capital, the formation of which requires people to save. However by keeping interest rates well below the rate of inflation, policymakers not only discourage saving, they actually destroy the savings already in existence, reducing our stock of capital. See: You Can’t Have Capitalism Without Capital.

Fiat Currency: Today, for the first time in history, all the world’s currencies are fiat, which means they are money only because of government edict, i.e. because the law says so. None of these currencies have any intrinsic value, nor are they backed by any kind of reserves, such as gold or silver, or any other portable, durable, easily divisible item that is likely to be accepted as payment. See: Why today’s system of fiat money is doomed to fail & what it means for investors.

High/ Rising Government Deficits: Thanks to their Keynesian economic philosophy and central banks that are willing to finance them, western governments are running huge and unsustainable deficits.

Gold Bull Market: Gold has been money for thousands of years and it is slowly reverting back to its historical role as money. Gold is the antithesis of fiat currencies. See: Why gold is money.

Stagflation: Many western economies are experiencing stagflation. Stagflation describes an economy in which inflation and unemployment are high and economic growth is low. See: Stagflation nation: Why Britain is heading for a quadruple-dip recession & a lost decade.

Unfunded Liabilities: Western economies such as the US and the UK have huge unfunded pension/ social security liabilities. In the US unfunded liabilities now total $238 trillion – over 16 times the official debt reported by the Treasury.

Fractional Reserve Lending: The practice of fractional reserve lending (which is prevalent today), allows banks to lend out more money than they hold on deposit. Under the system a bank with $10,000 can actually lend out $100,000. That’s because their required reserve ratio is 9 to 1 (normally expressed as 10%). See: A brief history of money & banking.

Negative Demographics (An ageing population): Thanks to an increase in life expectancy and declining birth rates, most developed countries are now faced with a significant increase in their elderly population. This is putting upward pressure on the cost of pensions and health care provision and represents a significant threat to their economies. In Britain for example, there are currently 4 people of working age supporting each pensioner, but by 2035 this number is expected to fall to 2.5, and by 2050 to just 2.

Bond Bubble: Thanks to central bank intervention the whole debt market including corporate bonds and high yield bonds is in a bubble. See: Bond bubble could see the sky-fall.

Zombie Companies: One in ten British businesses are “zombie companies” being kept alive by ultra-loose monetary policy and the reluctance of lenders to write-off bad loans. These companies cannot invest or innovate and therefore contribute to poor economic growth.

Declining Savings Rate: Between 1951 and 1992 household savings rates as a percent of disposable income were consistently between 7% and 11%. However, in the years that followed, income growth started to slow and rather than cut back their spending, consumers reduced their savings rate and went further and further into debt. By the time the Great Recession hit in 2007/08 the savings rate had dropped below 2%, however between 2008 and 2010 it rose quite sharply as consumers hunkered down. Over the last 2 years however, savings rates in the US, UK, Japan and Germany, have once again started to fall.

High/ Rising House Prices: Policymakers in the US and the UK are doing their best to support their mortgage and housing markets. The Fed, is buying mortgage-backed securities (bundled mortgages) issued by Fannie Mae and Freddie Mac, while the government here in the UK has launched its “Help to Buy” scheme which helps home buyers by guaranteeing mortgages or providing equity loans. These policies are designed to stimulate spending, and therefore GDP growth. See: The Help to Buy scheme is not the answer to Britain’s unaffordable housing, and How to profit from Osborne’s attempt to re-inflate Britain’s housing bubble, and The real price of UK property is already down 67% & it has much further to fall.

Currency Wars: Major economies around the world are engaged in a currency war in which they attempt to increase their exports by weakening their currencies. These competitive devaluations gathered pace in October 2012 when Fed Chairman Ben Bernanke admitted publically that it is the central bank’s intention to lower the exchange value of the dollar. This was quickly followed by the announcement that the BoJ would be intensifying its QE programme. See: Currency Wars Are Evil and Currency “War”?

Peak Oil: Oil is a finite non-renewable resource on which economic activity is almost entirely dependent. At some point the rate at which oil can be produced will reach its geological limit. This is known as “peak oil”. Conventional wisdom holds that world oil production will peak many years in the future allowing a timely transition to alternatives sources of energy. However a host of authoritative voices predict that it will occur as early as 2013 to 2015 – something that would have a profound effect on all our lives. See: Peak oil & its impact on the business cycle.

To see these forces in visual form, click here.

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