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The Cake-And-Eat-It era

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“It’s difficult enough even in normal times to get people to think about the unthinkable.” That’s according to William White, formerly of the Bank for International Settlements, ex-chairman of an OECD committee on economics and development, and one of the few economists who spotted the early warning signs of the 2008 Great Recession. A year ago he came out with another warning, the gist of which is that we are still living in abnormal times. His thoughtful worries can be watched here.

White is alarmed about the many instabilities of the global financial system, none of which, he argues, have been corrected since the 2008 crash. Not the least of those, he asserts, is the astonishing level of indebtedness today. We are experiencing that unusual phenomenon, a debt super-cycle, in which debt is not a problem as long as it is sustainable. Which is a bit like saying a balloon can carry on being inflated until it pops.

The chairman of the US Federal Reserve, Jerome Powell, does not share White’s nervousness however. On 14 November Powell told the US House of Representatives “if you look at today’s economy, there’s nothing that’s really booming now that would want to bust…it’s a pretty sustainable picture.” It’s Powell’s job to reassure markets, but his sanguine remarks cry out for a context.

Let’s personalise this for a moment. Even if you are debt-free your ‘share’ of the total global debt of $250 trillion (according to the Institute of International Finance), is about £23,000 for every man, woman, and child according to this alarming story from Bloomberg.  Global debt rose by a remarkable $7.5 trillion in the first half of 2019.

The overwhelming majority of this debt has been run up by governments trying their best to get their stagnant national economies working again, by essentially printing money and hoping these crisp new notes feed into the real economy. But, as many have said, hope is not a strategy.

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So you may feel as though your personal debt level is low – or even non-existent. But that won’t save you from the financial chaos that may result from the eventual unwinding of this debt. “Ominously,” said the Investor’s Chronicle in January this year, “the last debt super-cycle ended with World War II.”

Let’s hope however that the demise of the current super-cycle follows previous patterns: debt expansion is followed by bubble conditions for asset and equity prices; that’s followed by peak borrowing; and then step four is depression, with Gross Domestic Product (GDP) falling by 3% or more – which is what happened during the 2008 Great Recession.

But instead of central banks using the 2008 experience to encourage debt reduction, they have overseen 10 years of debt expansion. We have been living through what might be termed the great ‘Cake-And-Eat-It’ era, a period in which central banks have been printing money (Quantitative Easing) and sliding into negative interest rates, encouraging everyone to think that economic downturns are a thing of the past. Yet it is a patent absurdity that creditors are now paying for the privilege of lending money to governments.

We are not alone in thinking that many markets could be reaching exhaustion. Companies that essentially lack substance, such as Uber or WeWork, both of which no doubt provide a great service, have vastly inflated valuations yet have been loss-making for years. Or take Beyond Meat, which went public in early May this year and at its peak was valued at $15 billion, yet its 3rd quarter 2019 results showed gross net income was just $4.1 million.

If you incline more to the Jerome Powell view of things, then relax and hope that this massive debt bubble is sustainable – which it is, until it pops. But if you are more likely to think William White might have a point, then consider buying some gold on your Glint card. It seems to me that Kevin Duffy, co-founder of the US-based firm Bearing Asset Management, got it right when he said in a recent interview that “faith in central banking is at the heart of this bubble”. He added, significantly, that “precious metals are the inverse of faith in central banks.”

“The economy is not understandable and controllable, it is not a machine…you can’t understand where you are going until you understand where you have been.” The imbalances of 2007 and 2008 resulted in massive fiscal expansion, designed to encourage consumption, was very “inventive” says White. The global debt to gross domestic production ratio has gone from 192% to 230% by November 2017. “We have let this go on for such a long period of time – the debt trap big economic problems many big political problems too.

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