Global economy trapped between a rock and a hard place on money creation

The trick is working our way back through the monetary maze without being tripped back into recession in the process

PUBLISHED : Monday, 08 August, 2016, 1:59pm
UPDATED : Monday, 08 August, 2016, 11:41pm

Central banks are in a thankless position on monetary super-stimulus. It is a classic case of damned if you do and damned if you don’t.

Without prompt QE and zero interest rate actions after the 2008 crash, the world would have crashed into a deep, long-lasting depression. Now we are steeped up to our necks in a global pool of cheap derivative money with no easy way out.

The global financial crash almost brought the world to its knees after decades of reckless financial engineering and dodgy market practises. Global policymakers saved our skins by frantically printing money and crashing interest rates down to record low levels. But it has not been a strategy without significant risks. The trick now is working our way back through the monetary maze without being tripped back into recession in the process.

The risks are legion. The central banks might have rallied the markets and boosted economic confidence and growth, but there has been a massive misallocation of resources along the way. The flood of “junk” money has formed serious bubbles in asset markets, which are stacking up big problems for the future. It is not just the risk of “withdrawal symptoms” when the monetary taps are shut off. But it is also about what happens when super-stimulus eventually succeeds and inflation starts breaking higher again. This is what gives central bankers night terrors after dark.

Super-stimulus is the monetary ride that central bankers all fear. It is a dark labyrinth going in and even more of a monetary muddle finding the way back out. The central banks are flying blind, with little in the way of rule books or radar screens to plot the course ahead. For most of them it has been a case of “suck it and see” with mixed end-results. Pitfalls and risks are still littered about, not just economic dangers but political problems are mounting too.

The trick now is working our way back through the monetary maze without being tripped back into recession in the process

Take the case of the US. The bumper US jobs data last Friday, showing a 255,000 surge in new employment should have been joy to the US central bank’s ears, boosting expectations of accelerating economic growth and bolstering the case for more Fed monetary tightening later this year. But it compounds the dilemma. The Fed is dragging its feet because it knows the global economy is still too fragile to contend with higher borrowing costs either now or in future.

The weak economy aside, political risks are getting more acute as the November US Presidential election looms. The threat of a Trump presidency coupled with a Republican dominated House could pose serious risks to the US monetary puzzle especially if the Fed’s independence is put in jeopardy over its decision to dispose of its US$4.5 trillion QE asset pile. A flood of Fed-held US bonds returning too quickly to market could send global borrowing costs through the roof and world economic confidence crashing through the floor.

In the euro zone there are other kinds of risks. The European Central Bank is still fighting back-room battles with the conservative German Bundesbank which is extremely hostile to any more open-ended super-stimulus. Perpetual money printing and negative interest rates are anathema to Germany, stoking fears of an inflation spike. Any risk of Germany calling time on QE would spook markets and put stocks, bonds and the euro into a tailspin.

Meanwhile any viral spread of the UK’s anti-Europe germ could do untold damage to European financial stability in the long run. Euro scepticism is on the rise and any one country leaving the single currency could throw monetary union into tumult. With the ECB already holding the value of up to a quarter of euro zone GDP in the shape of government bonds and corporate debt, the toxic fall-out from any euro zone exit would send seismic shockwaves around the world.

With so much central bank derivative money floating around the world and the QE pot growing bigger by the day, a crisis in confidence could be looming soon. It is fine as long as sentiment stays intact, but the first sign of a major wobble could be the start of a new Doomsday scenario for consumers, businesses and investors. The only way out may be for the central banks to dig an even deeper hole by printing bigger piles of junk money.

This may be the age of funny money but it is not going to have a happy ending for anyone.

David Brown is chief executive of New View Economics