Liquidity Liquidity Every Where Will There Be a Recovery!!

Liquidity Liquidity Every Where Will There Be a Recovery!!

With the gush of liquidity from most Central banks around the world, the markets are moving to new highs without a real recovery in the earnings, will this ever greening of liquidity help in actual revive or does it just postpone the eventual danger of the collapse of markets world over.  

Policymakers have chosen to ignore the central issue of debt as they resuscitate activity. Since 2008, total public and private debt in major economies has increased by more than $60tn to more than $200tn about 300 per cent of global gross domestic product, an increase of more than 20 percentage points.

Over the past eight years, total debt growth has slowed but remains well above the corresponding rate of economic growth. Higher public borrowing to support demand and the financial system has offset modest debt reductions by businesses and households.

If the average interest rate is 2 per cent, then a 300 per cent debt to GDP ratio means that the economy needs to grow at a nominal rate of 6 per cent to cover interest.

Financial markets are now haunted by rising debt levels which constrain demand, as heavily indebted borrowers and nations are limited in their ability to increase spending. Debt service payments transfer income to investors with a lower marginal propensity to consume. Low interest rates are required to prevent defaults, reducing the income of savers, forcing additional savings to meet future needs and affecting the solvency of pension funds and insurance companies.

Policy normalization is difficult because higher interest rates would create problems for over-extended borrowers and inflict losses on bond holders. Debt also decreases flexibility and resilience, making economies vulnerable to shocks.

Attempts to increase growth and inflation to manage borrowing levels have had limited success. The recovery has been muted.

Sluggish demand, slowing global trade, capital flows and demographics, plus lower productivity gains and political uncertainty are all affecting activity. Meager commodity prices, especially energy, and overcapacity in many industries have kept inflation low.

In the absence of growth and inflation, the only real alternative is debt forgiveness or default. Savings designed to finance future needs, such as retirement, are lost.

Additional claims on the state to cover the shortfall or reduced future expenditure affect economic activity. Losses to savers trigger a sharp contraction of economic activity. Significant write downs create crises for banks and pension funds. Governments need to inject capital into banks to maintain the payment and financial system’s integrity.

Unable to grow, inflate, default or restructure their way out of debt, policymakers are trying to reduce borrowings by stealth. Official rates are below the true inflation rate so over-indebted borrowers to maintain sustainability high levels of debt. In Europe and Japan, disinflation requires implementation of negative interest rate policy, which entails an explicit reduction in the nominal face value of debt.

Debt monetisation and artificially suppressed or negative interest rates are a de -facto tax on holders of money and sovereign debt. It redistributes wealth over time from savers to borrowers and to the issuer of the currency, feeding social and political discontent as the Great Depression highlights.

The global economy might have become be trapped in a quantitative easing forever cycle. A weak economy forces policymakers to implement expansionary fiscal measures and QE.

If the economy responds, then the side-effects of QE encourage a withdrawal of the stimulus. Higher interest rates slow the economy and trigger financial crises, setting off a new round of the cycle.

If the economy does not respond or external shocks occur, then there is pressure for additional stimuli, as policymakers seek to maintain control.

Economist have been very pessimistic and feel that there is no means of avoiding the final collapse of a boom brought about by credit expansion. The point is   only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved. Negative rates are a de facto tax on holders of money and sovereign debt.

-        --Farzan Ghadially