“Insanity is doing the same thing over and over again and expecting different results.” Author unknown (but often, mistakenly) attributed to Einstein.
Ten years after the Lehman debacle: Will Central Bankers ever learn?
It has been just over 10 years since the Lehman Brothers bankruptcy. After the extra-ordinary measures that Governments and Central Bankers undertook in the aftermath of the GFC; notwithstanding the recent interest rate hike, we still have seen very small baby steps towards “normalization” (of interest rates), and so far, merely a stabilization, of the aggregate balance sheets of the CB’s.
The table below summarizes the issuance of what an Austrian Economist would call “fiduciary media” (central bank reserves) created since 2009.
We confess however, we remain massively puzzled that Central Bankers have been so successful in keeping the Asset Market party going for as long as they have. Even more so, that investors have so easily forgotten the two previous occasions where credit issuance, thin spreads in the credit markets and elevated equity valuations wreaked havoc on investors net worth. “Fool me once shame on you, fool me twice, shame on me”!
As investors with an Austrian Economics perspective, as much as the GFC was predictable in 2008 to Austrians- as indeed the Asian Crisis in 1998 or the Technology, Telecom & Media (TMT) bust in 2002 – by the extent of the credit booms that preceded both those events; the continuing enthusiasm for equity markets and the extreme under-pricing of credit risks by market participants (see chart below of -European high yield spreads vs US Treasuries),
behoves some introspection of the key Austrian (Economics) important tenets.
Try as we may, we find it difficult to subscribe to any of the new era thinking of effortless prosperity built on technological and productivity advances that justifies these asset valuations. We remember only too well that this is the same argument trotted out by financial intermediaries whenever strategists seek to justify high equity valuations.
To us the only plausible reason that CB’s have enjoyed the ability to keep the Asset party going for so long (as the chart below) is the substitution of a “commodity” money (read Gold) that existed prior to 1971 with a “credit” currency construct (The US Dollar & US Government Bonds).
As Warren Buffet said, “Nothing sedates rationality like large doses of effortless money.”
Since 1971, the distinction between “money”, “currency” and “credit “we believe, remains grossly misunderstood by market participants. The “holy grail” of interventionist monetary policy -an “elastic “currency-that Central Banks control without any ill-effects on goods and service price inflation, indeed seems to have been reached. At least for the US Dollar!
Currency creation at least in the modern era -restricted to the top 1% – seems to flow into asset price inflation. Think of a counterfeit so perfect that it is hard for almost all to notice the difference!
Indeed, visualize if you can, a formerly wealthy individual in a village, who became wealthy due to ingenuity, hard work and thrift of previous generations; but today, heavily in debt, this individual still enjoys the ability to have his IOU’s mandated as “currency” and treated by the world as “money”.
Not only does this individual have the store of accumulated wealth of his previous thrifty generations to bolster his creditworthiness; but several obliging “lenders” in the village are forced to follow his diktat by regulation. Finally, he can extract a tax on others in the village and in extremis even confiscate their wealth. No wonder the villagers-who easily obtain credit on the finest of terms against this “wealthy” individuals IOU’s- not only conflate “credit” with “money”, but the more IOU’s that are issued, the more prosperous they feel! See the chart below:
It will indeed take a long time for the villagers to understand the slow but steady ruin that they are inflicting on themselves. To quote Milton Friedman “Only government can take perfectly good paper, cover it with perfectly good ink and make the combination worthless.” Perhaps we need to add to that quote the word-“eventually”!
To Austrian economists what can only be characterized as “experiments” in extreme monetary policy, the reckless issuance of “fiduciary media” and the overt encouragement of credit profligacy, is most likely to end in a financial & monetary crisis so severe, that it would not surprise us to find that social and civic arrangements that underpin developed countries can plausibly rupture irreparably. It may even not be dissimilar to the scale and scope to what happened to the Soviet Bloc in the 1990’s.
As much as we have been able to understand the present circumstances, we confess we are equally hard pressed to give either a precise time or a precise path that “normalization” – of household net worth to GDP-will take shape. We would watch credit spreads and volatility but either way we have a strong feeling that ultimately “real assets” -especially “real money (Gold)” will trade far higher versus financial assets than they do now (see the chart below)