Trillion-dollar government spending programs have far exceeded the outlays following the 2008 financial crisis in Western countries, and go hand in hand with the gigantic government bond-buying programs and quantitative easing policies of central banks, which in turn flood the stock and capital markets with „liquidity.“ with their own money, which is then listed on their own balance sheets, thereby putting money into circulation themselves, which flows primarily into the financial markets. Central Banks act as Market-Makers and reactived highly the repo-activities. The fact that, since the 2008 financial crisis, the rapid rise in stock prices has almost paralleled the growth of the balance sheets of the major central banks suggests that the central banks‘ quantitative easing policies have a significant impact on stock market price increases.
With regard to the central banks‘ low interest rate policies, their proponents argue that they would encourage borrowing by companies and consumers. This has demonstrably failed to materialize after the 2008 financial crisis; instead, this monetary policy further increases demand for securities, equities, real estate, etc., and thus asset prices. Low interest rates generally reverse the relationship between incentives to save and incentives to borrow: Those who save money receive low amounts of money; those who borrow to speculate receive „cheap money“ and at least the option of high returns. Interest rates and prices of securities behave inversely to each other. The asset price increases resulting from the low interest rate policy make precisely those richer who already hold sufficient assets, thus favoring above all those who invest their assets in companies, securities, shares, real estate and derivatives. This, in turn, benefits the financial industry, which not only collects fees, bonuses and commissions by trading in assets, but also creates credit and realizes returns by buying securities.
Now, however, interest rates are rising right now in the bond markets for U.S. government bonds, even though the Fed is constantly buying them up on a large scale. At the end of March, the interest rate on 10-year U.S. Treasuries was 1.63 percent, and 30-year bonds were at 2.34 percent. Since interest rates on U.S. government bonds are the most important valuation factor for all other assets in the financial markets, a problem emerges here in that prices for stocks could now fall. There could be a movement toward relatively safe government bonds and away from the equity markets. In any case, this creates pressure on interest rates on mortgages, for example, and especially on corporate bonds, which can be extremely damaging for many U.S. companies.
So, since the beginning of the 2007 financial crisis, the money supply in the developed world has increased dramatically, partly as a result of central bank policies; the Fed has increased the money supply ninefold since 2007, the ECB has increased it sevenfold, and the Bank of England has also increased it ninefold. This was done mainly in two eruptions, the first to mitigate the effects of the 2007 financial crisis, the second to begin to address the economic consequences (unemployment and decline in growth) of the 2020 pandemic and lockdowns. The low interest rate policy and the purchase of securities by central banks leads to the increase of liquidity of private banks and also of companies, some of which remain in the market as non-profitable zombie companies.
(By issuing money as debt, first to governments as a form of „public“ debt and then to private individuals, commercial bank owners have created a financial system that offers banks and private investors a steady stream of capitalized income that guarantees them a source of power and influence with which to protect their various interests. This results from the ability of commercial banks to make mortgages, personal loans, auto loans, credit cards, home equity loans, and business loans. For example, if a bank makes a $500,000 loan on a home at 5% interest over 25 years, it does not create the $625,000 needed to repay the interest because the borrower now owes $1,125,000 (if annual simple interest is applied). Therefore, there is always more debt outstanding in the economy than there is ability to repay. The only way to temporarily overcome this structural gap is for additional individuals and institutions to take on more debt with a later maturity date than loans made to earlier parties. This structural feature of global capitalism, and the specific way in which new money is introduced in most economies, encourages competition for greater yield differentials so that debt can be repaid (others will go bankrupt)).
Some forecasts suggest that Fed and ECB balance sheets in the U.S. and eurozone could reach 50 percent of GDP or more by the end of 2021. This is independent of U.S. federal debt, which is currently over $27 trillion. U.S. federal debt has been rising steadily since the early 1980s, but since 2008 it has been rising exponentially, with some estimates suggesting it will reach 130 percent of U.S. GDP by the end of 2021. The flood of U.S. debt marks a global trend. Japan’s public debt is currently 230 percent of GDP, while China’s domestic debt (excluding external debt) is more than 300 percent of GDP
At the same time, private corporate and household debt, as well as sovereign debt, has also increased enormously, mainly due to the 2020 pandemic. The increase in debt worldwide from the third quarter of 2019 to the third quarter of 2020 is about $20 trillion. There is little chance that the debt will ever be paid off; rather, there will certainly be large debt defaults. While it is primarily private corporate debt that is being hedged today, that only brings more risk into play. In the case of government debt, Modern Money Theory has questioned whether it needs to be repaid at all. Its adherents say no, pointing out that this has never been the case; see the origins of central banking. For example, Japan is not expected to pay back the money it has created over the years, which now amounts to 200% of annual GDP. Still, the issue is more complicated.
After the 2007 financial crisis, bank demand shifted to another risky asset, collateralized loan obligations (CLOs). A CLO is structured similarly to a CDO, but instead of loans to homebuyers, loans are made to companies – especially ain troubled companies. CLOs bundle and structure leverage loans, the subprime mortgages of corporations. These are loans to companies that have reached their borrowing limit and are no longer able to sell bonds directly to investors or qualify for a traditional bank loan. Currently, more than $1 trillion worth of leveraged loans are outstanding in the U.S., with the majority held as CLOs.
While banks have held more capital to protect against a downturn since 2008, and their balance sheets are less leveraged today than in 2007, last year the Financial Stability Board estimated that for the 30 „global systemically important banks,“ the average exposure to leveraged loans and CLOs was about 60 percent of existing capital. Citigroup reported $20 billion worth of CLOs as of March 31; JPMorgan Chase reported $35 billion. Some mid-sized banks-California Banc and Stifel Financial-have CLOs worth more than 100 percent of their capital. If the market for CLOs were to implode, their liabilities could quickly become larger than their assets.
When you own a security, you assume that you will realize the money later and you can buy something with it. Assets and loans are based on promises to pay and on trust, but this can prove illusory. This can be seen, among other things, in the fact that the increase in money supply and debt is not matched by rising economic output; for example, real economic output fell by about 4.4 percent in 2020.
Now, Modern Money Theory, for example, maintains that central banks could continue to issue unlimited amounts of money and simply leave the key bank interest rate at zero for the next few decades, thereby not strengthening the real economy but further fueling the stock and real estate markets. Now, if the interest rate remains at or near zero in perpetuity, then the value of stocks and real estate could keep rising driven by the issuance of cheap money. Accordingly, the stock prices and real estate prices, in recent years and that even in times of the Corona lockdown apart from a few exceptions always further increased. This forces the central banks to keep interest rates so low. However, this leads to bubbles forming in the stock markets, debt defaults on derivatives such as CDLs, because zombie companies cannot be propped up forever, and in the real estate markets, real estate prices keep rising, but so do rents, which many of the lower income classes can barely afford.
The central banks‘ long-term zero interest rate and bond-buying policies inevitably fuel new financial crises. If we now end the low-interest-rate policy, as a result of which real interest rates also rise, many companies, households and many countries, including some of the industrialized countries, will become insolvent. Something similar will happen if interest rates on government bonds rise, even though central banks continue to buy up paper on a large scale.
Also, the government cannot create debt at will, because it is constantly valued on the secondary markets. Even cancelling the debt does not fix the problem, as the ECB has increased the liquidity of private banks by buying up government and corporate bonds in order to drive their power to create credit, thus creating giro money. This fiat money circulates even when the bonds are retired. When the Fed creates money, it buys bonds and other assets from multinational corporations and a small class of wealthy asset owners and replaces their securities with cash; likewise, it issues government bonds to the private market, where they then circulate as standard international safe assets for investors. This in turn drives further credit creation by private banks and other non-bank financial institutions in the shadow banking system. This unregulated, unsupervised collection of private equity funds, mutual funds, insurance companies, pension funds, and bank-created legal entities („special purpose vehicles“) is an important part of global money creation. Its total size has grown exponentially over the past two decades and now holds about $183 trillion or 49 percent of global financial assets. At 212 percent of global GDP, this exceeds even the balance sheets of the largest banks. It is no wonder that the shadow banking sector is funding the bulk of the recent record-breaking increase in corporate debt, which reached an all-time high in 2019.
A debt cut, in turn, would entail a reduction in wealth, something the rich won’t easily put up with. And inflation, while it would reduce debt in real terms, brings new problems, and it is also difficult to achieve given weak mass purchasing power and high excess capacity in industry.
More realistic will be a wave of bankruptcies and insolvencies, sovereign insolvencies and mass unemployment, and new uprisings on a global scale. For the economy, the coronavirus pandemic has already brought disrupted supply chains, record unemployment, failed small businesses, and further poverty for the masses. And there is just one more threat to the economy. It lurks on the balance sheets of the big banks, and it could be catastrophic for the entire economy. It is the possibility of a new financial crisis, because the banks have learned little from the last financial crisis, and the new decrees and laws that were supposed to keep them from taking on too much risk have had little effect to date. As a result, we may be on the precipice of another crisis, different from the 2008 financial crisis not so much in nature as in magnitude.
The question for investors is whether central banks can respond to rising inflationary pressures by raising interest rates on this huge mountain of debt without triggering a devastating shock to markets. Central banks know they can’t leave interest rates as low as they are because they will induce even more bad debt. But they can’t raise rates because then they would trigger the very crisis they are trying to avoid. And still the question of whether inflation or deflation is uncertain. If increasing aging has an inflationary effect (retirees don’t produce, but they do consume), higher inflation may also be the result of high government deficits being increasingly financed by central banks. Former Treasury Secretary Larry Summers and former IMF Chief Economist Olivier Blanchard both warned that passage of the proposed $1.9 billion spending package by the U.S. Congress, on top of last year’s $900 billion stimulus package, risks inflation. The combination of loose monetary policy, accumulated consumer savings that have not been able to spend, and already falling unemployment may contribute to rising inflationary pressures. On the other hand, zombie firms contribute to deflationary pressures due to favorable financing conditions and through excess capacity. There are hundreds of thousands of smaller companies that are nearly bankrupt and unable to start large investments even if they can get loans at low interest rates. The number of these zombie companies is growing by the day. It is also known that the enormous credit money injections by the Fed and other central banks that we have seen since the global financial crash of 2008 have not led to consumer price inflation in any major economy, but instead have led to an increase in financial asset prices. Banks and financial institutions, awash in the largesse of the Fed and other central banks, did not on-lend those funds (either because the large companies did not need loans or the small ones were too risky to lend). Instead, companies and banks speculated in the stock and bond markets, and in the face of low interest rates, borrowed even more (by issuing corporate bonds), paid out increased shareholder dividends, and bought back their own stock to boost prices. In addition, inflation tends to fall in capitalist economies because wages fall as a share of total value added and profits can come under pressure from an increasing organic composition of capital, i.e., more investment in machinery and technology relative to the workforce. In 2020, corporate profitability and profits fell sharply – with the exception of Big Tech, Big Finance and now Big Pharma. Wages also fell. These results have been deflationary. Still, the risk of inflation is rising more and more.
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