Lures of Monetary Immorality :: by Wilfred Hahn

Epochal challenges and upheavals are facing the world financial order. Many Western nations have fallen into classical debt traps; and economic growth rates for many countries have plummeted to a crawl. The largest nations and economic zones are facing continuing and unprecedented tremors. Japan, the third-largest country in the world economically, is caught in a demographic death spiral. The United States is headed for financial and economic suicide on its present course. Yet, many observers remain either unperturbed or complacent. They have no idea as to the continuing troubles ahead.

They are not entirely to blame. They have been lulled into believing that government interventions, bailouts and rescues will always carry the day, no matter how grave the crises may be. Little do they realize that consequences cannot be escaped. If anything, the ultimate crises and collapses will be worse than they needed to be, due to the many techniques used to kick the proverbial can down the road.

All of the problems we identify today are the direct consequence of past choices and unwise policies. The root problems, believe it or not, are fleshly and spiritual in nature. Of course, no card-carrying economist would offer such a diagnosis. We say spiritual in the sense that societies have increasingly staked their hopes upon beliefs that are false or non-sustainable, such as materialism, the ascendancy of the profit motive, neo-liberalism, and so on. We say fleshly in the sense that societies are increasingly engaged in the unbridled pursuit of fleshly fulfillment. Greed, aging societies, and widening inequity of wealth distribution are some of these manifestations.

These are deep problems of a moral nature that secular governments are ill-inclined to solve. What, therefore, is the solution? Apparently, the answer is very evident. Policymakers are looking to central bankers to come up with the fixes and/or deferrals. We are stunned to consider that any knowledgeable policymaker could actually believe that the “monetary wizards” who run central world banks and other financial transnational organizations can implement policies that will solve problems that are moral in nature. This would be patently ridiculous…to use fictitious money (itself immoral) to solve mankind’s moral deficiencies.

As such, we are inclined to believe that something very opposite will occur. Central banks will pursue even greater “monetary immorality.” In secular terms, this is called “unconventional policy” (something that does not involve morality). But, just what do we mean by “unconventional”? We think this term gives rise to some wild-cards that many savers and investors are not yet thinking about at this time.

Just as societies can change their popular views with respect to new fads and morals (no one makes a big deal about long hair and facial piercings anymore these days as was once the case), it is also this way with the accepted norms of monetary protocols. This changing of the “monetary morals” is already well underway. Many do not see this as they assume that central banks will someday unwind their interventions. Moreover, they are blinded by the accepted conventions of central bank accounting.

To demonstrate this last point, consider this question: If the U.S. Federal Reserve (Fed) buys up U.S. treasury bonds, is the debt-to-GDP ratio of the U.S. actually being lowered? We “predict” yes. How so? It will be an enticing solution. Consider the mechanism. The Fed pays for the U.S. treasury that it buys with new created money. It simply adds a liability to its balance sheet and shoves money out of thin air into the banking system. The cost of capital for the Fed is virtually nil and yet it now collects the interest payments earned by holding the U.S. treasury bonds. What happens to this income? It is added to the profitability of the Fed. At the end of every year, this central bank transfers its profits to the federal government.

What has happened? The interest cost of this debt has been lowered to the U.S. government (effectively, getting it rebated back). And, if the Fed never again sells down its treasuring holdings (maintaining them at the same level), isn’t this virtually the same as lowering the U.S. federal debt burden? Yes, so it will be perceived. It would be the equivalent of these bonds being retired. Yet, the accounting convention of the central bank will be to still show these bonds as an asset. What you see therefore promotes a structural illusion.

If global economic torpor and deflationary demand shocks continue, we would expect even more treasury bond purchases by the Fed (this applying to other central banks as well…i.e. the ECB). Why wouldn’t policymakers propose retiring massive amounts of government debt in this way? This would appear to be so much more pleasant than intolerant austerity policies…so seemingly painless. Of course, this perception couldn’t be more wrong, though surely alluring and easily pandered.

The deterioration in “monetary morals” can go much further. In fact, we will not be surprised if it slides much, much further. There is not a small number of policymakers that have broached the topic of “unconventional” monetary tactics. The signs of such central banking shifts are being seen around the globe.

The IMF (International Monetary Fund) explored the topic of budget spending multipliers in its recent Outlook. It argued that the “fiscal multipliers” are much higher than thought, therefore implying that budget deficit cuts may actually lead to higher deficits. If they are not to be cut, then on this logic does it not follow that even higher deficit spending would be even better? But just who would be financing such endless and stupendous government deficits? Central banks, of course.

There is one further step that could follow in this slide, and that is to have central banks directly buy the debt instruments of governments (i.e. circumventing the route of buying them in the open market). We would not be surprised if Japan were soon to adopt such a desperate policy. At this point, some laws and statutes stand in the way of such activities; however, it is likely that necessity will pay little heed to such restrictions.

Our conclusion is this: Long-term developments look challenging and grim. As such, we are inclined to believe that the downhill slide of “monetary morality” has not finished its course given its many willing complicitors. But, the ultimate fall-out cannot be avoided. We think that all of these current and future developments are very unfortunate as none resolve the underlying problems but rather only redirect their impact to a more deceptive and unsuspecting path, thus “kicking the can down the road” toward to even greater disruptions and crises.