On the IMF Warning

by James Staudt, PhD, CFA

Copyright 2016, all rights reserved

As noted on today’s front page article in the Financial Times, the International Money Fund has issued a warning that global debt, at a record of $152 trillion, or 225% of global GDP, poses a threat to the global economy.  Most of that debt – about two thirds of it – is private sector debt.   The IMF acknowledges the role of central banks by stating that debt has grown very rapidly since the financial crisis as central banks have been promoting debt expansion in an effort to promote economic growth. 

This is the challenge that we are faced with today after decades of debt fueled stimulus.  Economists have, for decades, ignored the risks of ever increasing debt levels because of their faith in their economic models that conveniently also ignore the risks of increasing debt levels.  This is also why their models are unable to anticipate financial crises.  It is like a weather forecasting model that ignores the role that ocean temperatures have on creating hurricanes.  This has allowed economists, including those in the academic community, to promote policies that are in the interests of their clients (such as investment banks, like Goldman Sachs) while conveniently ignoring the risks of these policies to the rest of us.

Our central bank, as well as other central banks, has been a major culprit in creating this situation.  As Mohammed El-Erian notes in his book The Only Game In Town, central banks felt that unconventional (and untested) means of stimulus were necessary to initially address the banking crisis and then to promote growth.  The use of these methods for such a prolonged period after the financial crisis created risks as well as an apparent windfall for the financial classes while not providing the kind of durable economic growth Main Street had hoped for.  Increased debt, whether public or private debt, poses risks, but the ease at which central banks can create money has created an illusion that debt is risk free and does not impose a cost.

The dilemma with debt is the fundamental problem that you are spending today what would be available for you in the future.  If your spending is on productive assets, like infrastructure or factory machinery, etc., this might provide more for you in the future.  But, if the debt is used to spend today simply for the sake of consumption or it is spent on productive assets that don’t provide an adequate future return, you dig yourself a hole.  Central banks can implement policies that promote or discourage use of debt, but they can’t tell people how to use that debt (nor should they).  The answer to this problem for the central banks has been to simply create more money, but this has a punishing effect on some while creating a windfall for others, without doing anything to promote investment in productive assets.

But, this gets to a very fundamental question.  Imagine a place where a group of unelected officials, not accountable to anyone, make key decisions about who are economic winners and losers.  You might think that this sounds like the old Soviet Union.  But, it is right here in the United States as well as other countries.  Our central bank has effectively been stealing from savers planning for future obligations (individual savers, pension funds, insurance companies) and giving it to those who are deeply in debt (investment banks, private equity funds, individuals who are over-extended on debt, and, of course, our federal government).  These policies have also promoted increased use of debt for no or low return investment, exacerbating the long term debt problem further.  It also raises the question of whether or not the central bank should really have such an outsized role in our economy without any oversight.  I will explore this in an upcoming blogpost.

Getting back to stimulus through debt, normally, such policies would punish a nation’s currency with high inflation.  But, with virtually every nation on earth pursuing these policies, it has become a race to the bottom.  Because global economic growth is so slow, nations are trying to grow by "stealing" growth from other nations though weak currency policies.  Are there periods in the past that we can look to for guidance?  I'm afraid so, but they are not a source of optimism. The period after World War I was the last time that most of the developed world was pursuing such policies.  The German Weimar Republic was printing money in an effort to promote the domestic economy while it was suffering under highly punitive war reparations to France.  France was deeply in debt to England, and England to the United States.  These nations, having abandoned monetary standards were printing money and experiencing high inflation.  Global trade also dropped as nations adopted "beggar thy neighbor" policies.  The United States for its part was on a debt binge that fueled a real estate and stock market bubble.  Inflation on consumer goods wasn’t a problem in the United States due to a gold standard and because, on balance, we were the largest creditor country.  However, we know how badly things ended that time. 

Let’s pray for a happier ending this time around.

On the IMF Warning

by James Staudt, PhD, CFA

Copyright 2016, all rights reserved

As noted on today’s front page article in the Financial Times, the International Money Fund has issued a warning that global debt, at a record of $152 trillion, or 225% of global GDP, poses a threat to the global economy.  Most of that debt – about two thirds of it – is private sector debt.   The IMF acknowledges the role of central banks by stating that debt has grown very rapidly since the financial crisis as central banks have been promoting debt expansion in an effort to promote economic growth. 

This is the challenge that we are faced with today after decades of debt fueled stimulus.  Economists have, for decades, ignored the risks of ever increasing debt levels because of their faith in their economic models that conveniently also ignore the risks of increasing debt levels.  This is also why their models are unable to anticipate financial crises.  It is like a weather forecasting model that ignores the role that ocean temperatures have on creating hurricanes.  This has allowed economists, including those in the academic community, to promote policies that are in the interests of their clients (such as investment banks, like Goldman Sachs) while conveniently ignoring the risks of these policies to the rest of us.

Our central bank, as well as other central banks, has been a major culprit in creating this situation.  As Mohammed El-Erian notes in his book The Only Game In Town, central banks felt that unconventional (and untested) means of stimulus were necessary to initially address the banking crisis and then to promote growth.  The use of these methods for such a prolonged period after the financial crisis created risks as well as an apparent windfall for the financial classes while not providing the kind of durable economic growth Main Street had hoped for.  Increased debt, whether public or private debt, poses risks, but the ease at which central banks can create money has created an illusion that debt is risk free and does not impose a cost.

The dilemma with debt is the fundamental problem that you are spending today what would be available for you in the future.  If your spending is on productive assets, like infrastructure or factory machinery, etc., this might provide more for you in the future.  But, if the debt is used to spend today simply for the sake of consumption or it is spent on productive assets that don’t provide an adequate future return, you dig yourself a hole.  Central banks can implement policies that promote or discourage use of debt, but they can’t tell people how to use that debt (nor should they).  The answer to this problem for the central banks has been to simply create more money, but this has a punishing effect on some while creating a windfall for others, without doing anything to promote investment in productive assets.

But, this gets to a very fundamental question.  Imagine a place where a group of unelected officials, not accountable to anyone, make key decisions about who wins and who loses in our economy.  You might think that this sounds like the old Soviet Union.  But, it is right here in the United States as well as other countries.  Our central bank has effectively been stealing from savers planning for future obligations (individual savers, pension funds, insurance companies) and giving it to those who are deeply in debt (investment banks, private equity funds, and individuals who are over-extended on debt).  These policies have also promoted increased use of debt for no or low return investment, exacerbating the debt problem further.  It also raises the question of whether or not the central bank should really have such an outsized role in our economy without any oversight.  I will explore this in an upcoming blogpost.

Getting back to stimulus through debt, normally, such policies would punish a nation’s currency with high inflation.  But, with virtually every nation on earth pursuing these policies, it has become a race to the bottom.  Because global economic growth is so slow, nations are trying to grow by "stealing" growth from other nations though weak currency policies.  Are there periods in the past that we can look to for guidance?  I'm afraid so, but they are not a source of optimism. The period after World War I was the last time that most of the developed world was pursuing such policies.  The German Weimar Republic was printing money in an effort to promote the domestic economy while it was suffering under highly punitive war reparations to France.  France was deeply in debt to England, and England to the United States.  These nations, having abandoned monetary standards were printing money and experiencing high inflation.  Global trade also dropped as nations adopted "beggar thy neighbor" policies.  The United States for its part was on a debt binge that fueled a real estate and stock market bubble.  Inflation on consumer goods wasn’t a problem in the United States due to a gold standard and because, on balance, we were the largest creditor country.  However, we know how badly things ended that time. 

Let’s pray for a happier ending this time around.