Code Red

That's the title of John Mauldin's new book, published a few days ago.

Here's an excerpt from the book's Introduction.

The money printing that central bankers did after the failure of Lehman Brothers was entirely appropriate in order to avoid a Great Depression II. The Fed and central banks were merely creating some money and credit that only partially offset the contraction in bank lending.

The initial crisis is long gone, but the unconventional measures have stayed with us. Once the crisis was over, it was clear that the world was saddled with high debt and low growth. In order to fight the monsters of deflation and depression, central bankers have gone wild. Central bankers kept on creating money. Quantitative easing was a shocking development when it was first trotted out, but these days the markets just shrug. Now, the markets are worried about losing their regular injections of monetary drugs. What will withdrawal be like?

The amount of money central banks have created is simply staggering. Under quantitative easing, central banks have been buying every government bond in sight and have expanded their balance sheets by over nine trillion dollars. Yes, that's $9,000,000,000,000 - twelve zeros to be exact. (By the time you read this book, the number will probably be a few trillion higher, but who is counting?) Numbers so large are difficult for ordinary humans to understand.

. . .

In the bizarre world we now inhabit, central banks and governments try to induce consumers to spend to help the economy while they take money away from savers who would like to be able to profitably invest. Rather than inducing them to consume more, they are forcing them to spend less in order to make their savings last through their final years!

Savers and investors in the developed world are the guinea pigs in an unprecedented monetary experiment. There are clear winners and losers as prudent savers are called upon to bail out reckless borrowers. In the US, UK, Japan, and most of Europe, savers receive close to zero percent interest on their savings while they watch the price of gasoline, groceries, and rents go up. Standards of living are falling for many and economic growth is elusive. Today is a time of financial repression, where central banks keep interest rates below inflation. This means that the interest savers receive on their deposits cannot keep up with the rising cost of living. Big banks are bailed out and continue paying large bonuses while older savers are punished.

. . .

Bernanke understands that the world has far too much debt that it can't pay back. Sadly, debt can only go away via:

1. defaults (and there are so many ways to default without having to actually use the word!);
2. paying down debt through economic growth, or
3. eroding the burden of debt through inflation or devaluations.

In our grandparents' age, we would have seen defaults. But defaults are painful, and no one wants them. We've grown fat and comfortable. We don't like pain. Growing our way out of our problems would be ideal, but it isn't an option. Economic growth is elusive everywhere we look. Central bankers are left with no other option but to create inflation and devalue their currencies.

No one wants to hear that we'll suffer from higher inflation. It is grotesque and not what central bankers are meant to do.  But ... inflation is exactly what the central bankers are preparing for us. They're sparing some the pain of defaults while others bear the pain of low returns. But a world in which big banks and governments default is almost by definition a world of not just low but (sometimes steeply) negative returns. As we said in Endgame, we are left with no good choices, only choices that range from the merely very difficult to the downright disastrous.

. . .

Ben Bernanke, Mario Draghi, Haruhiko Kuroda, and other central bankers are manning their battle station using ugly means to get the job done. They are punishing savers, encouraging people to borrow more, providing lots of liquidity, and weakening their currencies.

This unprecedented global monetary experiment has only just begun, and every central bank is trying to get in on the act. It is a monetary arms race, and no one wants to be left behind. The Bank of England has devalued the pound to improve exports by allowing creeping inflation and keeping interest rates at zero. The Federal Reserve has tried to weaken the dollar in order to boost manufacturing and exports. The Bank of Japan, not to be outdone, is now trying to depreciate the yen. By weakening their currencies, they hope to boost their exports and get a leg up on their competitors. In the race to debase currencies, no one wins.

Emerging market countries like Brazil, Russia, Malaysia, and Indonesia will not sit idly by while developed central banks weaken their currencies. They are fighting to keep their currencies from appreciating. They are imposing taxes on investments and savings in their currencies. Countries are turning protectionist. The battles have only begun in what promises to be an enormous, ugly currency war. If the currency wars of the 1930s and 1970s are any guide, we will see knife fights ahead. Governments will fight dirty, they will impose tariffs and restrictions and capital controls. It is already happening and we will see a lot more of it.

. . .

The arsonists are now running the fire brigade. Central bankers contributed to the economic crisis the world now faces. They kept interest rates too low for too long. They fixated on controlling inflation, even as they stood by and watched investment banks party in an orgy of credit. Central bankers were completely incompetent and failed to see the Great Financial Crisis coming. They couldn't spot housing bubbles, and even when the crisis had started and banks were failing, they insisted that the banks they supervised were well regulated and healthy. They failed at their job and should have been fired. Yet governments now need central banks to erode the mountain of debt by printing money and creating inflation.

Investors should ask themselves: if central bankers couldn't manage conventional monetary policy well in the good times, what makes us think that they will be able to manage unconventional monetary policies in the bad times?

There's more at the link.  Bold, underlined text is my emphasis.

As if to confirm the book's forecast, today the New York Times headlined a report 'In Fed and out, many now think inflation helps'. Here's an excerpt.

The Fed has worked for decades to suppress inflation, but economists, including Janet Yellen, President Obama’s nominee to lead the Fed starting next year, have long argued that a little inflation is particularly valuable when the economy is weak. Rising prices help companies increase profits; rising wages help borrowers repay debts. Inflation also encourages people and businesses to borrow money and spend it more quickly.

. . .

All this talk has prompted dismay among economists who see little benefit in inflation, and who warn that the Fed could lose control of prices as the economy recovers. As inflation accelerates, economists agree that any benefits can be quickly outstripped by the disruptive consequences of people rushing to spend money as soon as possible. Rising inflation also punishes people living on fixed incomes, and it discourages lending and long-term investments, imposing an enduring restraint on economic growth even if the inflation subsides.

“The spectacle of American central bankers trying to press the inflation rate higher in the aftermath of the 2008 crisis is virtually without precedent,” Alan Greenspan, the former Fed chairman, wrote in a new book, “The Map and the Territory.” He said the effort could end in double-digit inflation.

Again, more at the link.

I've lived in a high-inflation economy for many years, back in South Africa. I've seen how it can devastate one's financial planning, and cripple those living off their savings or fixed incomes, such as pensioners.  To give just one example, the very nice bachelor apartment I rented in Cape Town for R60 per month in 1978 - the equivalent of US $25-$30 in those days - today rents for R3,500, an increase of about 5,700%.  Thanks to the effect of inflation (amongst other influences) on the exchange rate, the South African Rand buys a lot fewer dollars than it used to, so the higher rent is now equivalent to US $250 or thereabouts.

Inflation is disastrous - yet our economic masters appear to be actively embracing the concept as the only way out of the debt crisis.  I think that particular cure will prove much worse than our present fiscal disease, but they won't listen to people like me.  We're not among the 'elite' whose opinions they value.  We don't count.  Ours not to reason why . . . ours but to suffer the consequences of their hubris.  We can only hope and pray that it doesn't lead to nemesis, because the latter is no respecter of persons or station in life.  It'll nail all of us.


Peter