Late in the life of every financial bubble, when things have gotten so out
of hand that the old ways of judging value or ethics or whatever can no longer
be honestly applied, a new idea emerges that, if true, would let the bubble
keep inflating forever. During the tech bubble of the late 1990s it was the "infinite
Internet." Soon, we were told, China and India's billions would enter cyberspace.
And after they were happily on-line, the Internet would morph into versions
2.0 and 3.0 and so on, growing and evolving without end. So don't worry about
earnings; this is a land rush and "eyeballs" are the way to measure virtual
real estate. Earnings will come later, when the dot-com visionaries cash out
and hand the reins to boring professional managers.
During the housing bubble the rationalization for the soaring value of inert
lumps of wood and Formica was a model of circular logic: Home prices would
keep going up because "home prices always go up."
Now the current bubble - call it the Money Bubble or the sovereign debt bubble
or the fiat currency bubble, they all fit - has finally reached the point where
no one operating within a historical or commonsensical framework can accept
its validity, and so for it to continue a new lens is needed. And right on
schedule, here it comes: Governments with printing presses can create as much
currency as they want and use it to hold down interest rates for as long as
they want. So financial crises are now voluntary. They only happen if a country
decides to stop depressing interest rates - and why would they ever do that?
Here's an article out of the UK that expresses this belief perfectly:
Our debt is no Greek
tragedy
"The threat of rising interest rates is a Greek tragedy we must avoid." This
was the title of a 2009 Daily Telegraph piece by George Osborne, pushing massive
spending cuts as the only solution to a coming debt crisis. It's tempting to
believe anyone who still makes it is either deliberately disingenuous, or hasn't
been paying attention.
The line of reasoning goes as follows: Britain's high and rising public
debt causes investors to take fright and sell government bonds because the
UK might default on those bonds.
Interest rates then spike up because as less people want to hold UK debt,
the government has to pay them more for the privilege, so that the cost of
borrowing becomes more expensive and things become very, very bad for everyone.
This argument didn't make sense back in 2009, and certainly doesn't make
sense now. Ultimately this whole Britain-as-Greece argument is disturbing
because it makes the austerity project of the last three years look deeply
duplicitous.
If you go to any bond desk in the City that trades British sovereign debt,
money managers care about one thing - what the Bank of England does or doesn't
do. If Governor Mark Carney says interest rates should fall and looks like
he believes it, they fall. End of story.
Why? Because the Bank directly controls the interest rate on short-term
government debt, so it can vary it at will in line with any given objective.
Interest rates on long-term government debt are governed by what markets
expect to happen to short term rates, and so are subject to essentially the
same considerations.
It doesn't matter if investors get scared and dump government bonds because
this has no implication for interest rates - it is what the Bank of England
wants to happen that counts.
If investors do suddenly decide to flee en masse, the Bank can simply use
its various tools to bring interest rates back into line.
The simple point is that since countries like the UK have a free-floating
currency, the Bank of England doesn't have to vary interest rates to keep
the exchange rate stable. Therefore it, as an independent central bank, can
prevent a debt crisis by controlling the cost of government borrowing directly.
Investors understand this, and so don't flee British government debt in the
first place.
Greece and the other troubled Eurozone countries are in a totally different
situation. They don't have their own currency, and have a single central
bank, the ECB, which tries to juggle the needs of 17 different member states.
This is a central bank dominated by Germany, which apparently isn't bothered
by letting the interest rates of other nations spiral out of control. Investors,
knowing this, made it happen during the financial crisis.
On these grounds, the case of Britain and those of the Eurozone countries
are not remotely comparable - and basic intuition suggests steep interest
rate rises are only possible in the latter.
Britain was never going to enter a sovereign debt crisis. It has everything
to do with an independent central bank, and nothing to do with the size of
government debt. How well does this explanation stand up given the events
of the last few years? Almost perfectly. The US, Japan and the UK are the
three major economies with supposed debt troubles not in the Eurozone.
The UK released a plan in 2010 to cut back a lot of spending and raise a
little bit of tax money. The US did nothing meaningful about its debt until
2012, and has spent much of the time before and since pretending to be about
to default on its bonds. Japan's debt patterns are, to put it bluntly, screwed
- Japan's debt passed 200 per cent of GDP earlier this year and is rising
fast.
But the data shows that none of this matters for interest rates whatsoever.
Rates have been low, stable and near-identical in all three countries regardless
of whatever their political leaders' actions.These countries have had vastly
different responses to their debt, and markets don't care at all.
By the same token, the problems of spiking interest rates inside the Eurozone
have nothing to do with the prudence or spending of the governments in charge.
Spain and Ireland both had debt of less than 50 per cent of GDP before the
crisis and were still punished by markets. France and the holier-than-thou
Germany had far higher debt in 2007, and are fine.
The takeaway is that problems with spiking interest rates amongst advanced
countries are entirely restricted to the Eurozone, where there is a single
central bank, and have no obvious relation to the state of public finances.
So what we have, then, is a disturbingly mendacious line of reasoning .
Back in 2010 the Conservative party made a perhaps superficially plausible
argument about national debt that was wrong then and is doubly wrong now.
They then - sort of - won a mandate to govern based on this, and used it
to radically alter the size of the state. The likelihood that somehow this
was all done in good faith beggars belief.
Britain has had a far higher proportion of austerity in the form of spending
cuts than tax rises relative to any comparator nation. On this basis austerity
is a way of reshaping the state in the Conservative image, flying under the
false flag of debt crisis-prevention.
If the British public had knowingly and willingly voted for the major changes
made under the coalition in how the government taxes, spends and borrows,
this wouldn't be such a great problem.
Instead, they were essentially conned into it by the ridiculous story of
Britain as the next Greece.
Some thoughts
What's great about the above article is that it doesn't beat around the bush.
Without the slightest hint of irony or historical sense, it lays out the bubble
rationale, which is that central banks are all-powerful: "If you go to any
bond desk in the City that trades British sovereign debt, money managers care
about one thing - what the Bank of England does or doesn't do. If Governor
Mark Carney says interest rates should fall and looks like he believes it,
they fall. End of story."
So this is the end of history. Interest rates will stay low and stock prices
high and governments will keep on piling up debt with impunity - because they
control the financial markets and get to decide which things trade at what
price. Breathtaking! Why didn't humanity discover this financial perpetual
motion machine earlier? It would have saved thousands of years of turmoil.
At the risk of looking like a bully, let's consider another peak-bubble gem:
"The simple point is that since countries like the UK have a free-floating
currency, the Bank of England doesn't have to vary interest rates to keep
the exchange rate stable. Therefore it, as an independent central bank, can
prevent a debt crisis by controlling the cost of government borrowing directly.
Investors understand this, and so don't flee British government debt in the
first place."
The writer is saying, in effect, that the value of the British pound - and
by extension any other fiat currency - can fall without consequence, and that
the people who might want to use those currencies in trade or for savings will
continue to do so no matter how much the issuer of those pieces of paper owes
to others in the market. If holders of pounds decide to switch to dollars or
euros or gold, that's no problem for Britain because it can just buy all the
paper thus freed up with new pieces of paper.
This illusion of government omnipotence is no crazier than the infinite Internet
or home prices always going up, but it is crazy. Governments couldn't stop
tech stocks from imploding or home prices from crashing, and when the time
comes, the Bank of England, the US Fed, and the Bank of Japan won't be able
to stop the markets from dumping their currencies. Nor will they be able to
stop the price of energy, food, and most of life's other necessities from soaring
when the global markets lose faith in their promises.
