Conjuring Up the Next Depression

11 09 2018

chrishedges

Chris Hedges

During the financial crisis of 2008, the world’s central banks, including the Federal Reserve, injected trillions of dollars of fabricated money into the global financial system. This fabricated money has created a worldwide debt of $325 trillion, more than three times global GDP. The fabricated money was hoarded by banks and corporations, loaned by banks at predatory interest rates, used to service interest on unpayable debt or spent buying back stock, providing millions in compensation for elites. The fabricated money was not invested in the real economy. Products were not manufactured and sold. Workers were not reinstated into the middle class with sustainable incomes, benefits and pensions. Infrastructure projects were not undertaken. The fabricated money reinflated massive financial bubbles built on debt and papered over a fatally diseased financial system destined for collapse.

What will trigger the next crash? The $13.2 trillion in unsustainable U.S. household debt? The $1.5 trillion in unsustainable student debt? The billions Wall Street has invested in a fracking industry that has spent $280 billion more than it generated from its operations? Who knows. What is certain is that a global financial crash, one that will dwarf the meltdown of 2008, is inevitable. And this time, with interest rates near zero, the elites have no escape plan. The financial structure will disintegrate. The global economy will go into a death spiral. The rage of a betrayed and impoverished population will, I fear, further empower right-wing demagogues who promise vengeance on the global elites, moral renewal, a nativist revival heralding a return to a mythical golden age when immigrants, women and people of color knew their place, and a Christianized fascism.

The 2008 financial crisis, as the economist Nomi Prins points out, “converted central banks into a new class of power brokers.” They looted national treasuries and amassed trillions in wealth to become politically and economically omnipotent. In her book “Collusion: How Central Bankers Rigged the World,” she writes that central bankers and the world’s largest financial institutions fraudulently manipulate global markets and use fabricated, or as she writes, “fake money,” to inflate asset bubbles for short-term profit as they drive us toward “a dangerous financial precipice.”

“Before the crisis, they were just asleep at the wheel, in particular, the Federal Reserve of the United States, which is supposed to be the main regulator of the major banks in the United States,” Prins said when we met in New York. “It did a horrible job of doing that, which is why we had the financial crisis. It became a deregulator instead of a regulator. In the wake of the financial crisis, the solution to fixing the crisis and saving the economy from a great depression or recession, whatever the terminology that was used at any given time, was to fabricate trillions and trillions of dollars out of an electronic ether.”

The Federal Reserve handed over an estimated $29 trillion of this fabricated money to American banks, according to researchers at the University of MissouriTwenty-nine trillion dollars! We could have provided free college tuition to every student or universal health care, repaired our crumbling infrastructure, transitioned to clean energy, forgiven student debt, raised wages, bailed out underwater homeowners, formed public banks to invest at low interest rates in our communities, provided a guaranteed minimum income for everyone and organized a massive jobs program for the unemployed and underemployed. Sixteen million children would not go to bed hungry. The mentally ill and the homeless—an estimated 553,742 Americans are homeless every night—would not be left on the streets or locked away in our prisons. The economy would revive. Instead, $29 trillion in fabricated money was handed to financial gangsters who are about to make most of it evaporate and plunge us into a depression that will rival that of the global crash of 1929.

Kevin Zeese and Margaret Flowers write on the website Popular Resistance, “One-sixth of this could provide a $12,000 annual basic income, which would cost $3.8 trillion annually, doubling Social Security payments to $22,000 annually, which would cost $662 billion, a $10,000 bonus for all U.S. public school teachers, which would cost $11 billion, free college for all high school graduates, which would cost $318 billion, and universal preschool, which would cost $38 billion. National improved Medicare for all would actually save the nation trillions of dollars over a decade.”

An emergency clause in the Federal Reserve Act of 1913 allows the Fed to provide liquidity to a distressed banking system. But the Federal Reserve did not stop with the creation of a few hundred billion dollars. It flooded the financial markets with absurd levels of fabricated money. This had the effect of making the economy appear as if it had revived. And for the oligarchs, who had access to this fabricated money while we did not, it did.

The Fed cut interest rates to near zero. Some central banks in Europe instituted negative interest rates, meaning they would pay borrowers to take loans. The Fed, in a clever bit of accounting, even permitted distressed banks to use these no-interest loans to buy U.S. Treasury bonds. The banks gave the bonds back to the Fed and received a quarter of a percent of interest from the Fed. In short, the banks were loaned money at virtually no interest by the Fed and then were paid interest by the Fed on the money they borrowed. The Fed also bought up worthless mortgage assets and other toxic assets from the banks. Since Fed authorities could fabricate as much money as they wanted, it did not matter how they spent it.

“It’s like going to someone’s old garage sale and saying, ‘I want that bicycle with no wheels. I’ll pay you 100 grand for it. Why? Because it’s not my money,’ ” Prins said.

“These people have rigged the system,” she said of the bankers. “There is money fabricated at the top. It is used to pump up financial assets, including stock. It has to come from somewhere. Because money is cheap there’s more borrowing at the corporate level. There’s more money borrowed at the government level.”

“Where do you go to repay it?” she asked. “You go into the nation. You go into the economy. You extract money from the foundational economy, from social programs. You impose austerity.”

Given the staggering amount of fabricated money that has to be repaid, the banks need to build greater and greater pools of debt. This is why when you are late in paying your credit card the interest rate jumps to 28 percent. This is why if you declare bankruptcy you are still responsible for paying off your student loan, even as 1 million people a year default on student loans, with 40 percent of all borrowers expected to default on student loans by 2023. This is why wages are stagnant or have declined while costs, from health care and pharmaceutical products to bank fees and basic utilities, are skyrocketing. The enforced debt peonage grows to feed the beast until, as with the subprime mortgage crisis, the predatory system fails because of massive defaults. There will come a day, for example, as with all financial bubbles, when the wildly optimistic projected profits of industries such as fracking will no longer be an effective excuse to keep pumping money into failing businesses burdened by debt they cannot repay.

“The 60 biggest exploration and production firms are not generating enough cash from their operations to cover their operating and capital expenses,” Bethany McLean writes of the fracking industry in an article titled “The Next Financial Crisis Lurks Underground” that appeared in The New York Times. “In aggregate, from mid-2012 to mid-2017, they had negative free cash flow of $9 billion per quarter.”

The global financial system is a ticking time bomb. The question is not if it will explode but when it will explode. And once it does, the inability of the global speculators to use fabricated money with zero interest to paper over the debacle will trigger massive unemployment, high prices for imports and basic services, and a devaluation in which the dollar will become nearly worthless as it is abandoned as the world’s reserve currency. This manufactured financial tsunami will transform the United States, already a failed democracy, into an authoritarian police state. Life will become very cheap, especially for the vulnerable—undocumented workers, Muslims, poor people of color, girls and women, anti-capitalist and anti-imperialist critics branded as agents of  foreign powers—who will be demonized and persecuted for the collapse. The elites, in a desperate bid to cling to their unchecked power and obscene wealth, will disembowel what is left of the United States.

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Money trees are magical; energy trees are not

9 08 2018

Another excellent post from the Consciousness of Sheep……..  a bit anglo-centric, but easily applies to anywhere not least Australia.

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Equating money with wealth is among the most dangerous delusions currently afflicting humanity.

This is, perhaps, understandable given that so few people now have access to money in the quantities needed to improve their lives.

Government, meanwhile, effectively lies when it points to the various pots of money that it has allocated to this or that infrastructure, entitlement or service.  This is mendacious because money from central government is allocated as a block grant to local government and other public bodies.  In total, these public bodies lack the income to fund their legal responsibilities.  As a result, money that was theoretically allocated to provide for such things as mental health beds, fixing potholes and a host of other discretionary activities is actually deployed in firefighting the collapse of mandatory services like child welfare or social care for the elderly.

The solution to this for many in the political sphere is to loosen the purse strings.  Quite correctly, they identify the central flaw in the pronouncements of duplicitous politicians like Theresa May and Phillip Hammond; who tell us that “there isn’t a magic money tree.”  Because… well… actually, yes there is.  It’s called the Bank of England.  And were politicians to instruct it to do so, it can spirit into existence as much new currency as it likes.

The conventional way in which central banks spirit money into existence is via the issuance of government debt.  Government issues a bond (called a Gilt-Edged Security in the UK) which is auctioned to a closed group of banks and financial institutions.  The central bank then spirits new money into existence and uses it to buy these bonds back.  That new money then enters the economy via the financial sector.

This, of course, is no more than tradition.  There is nothing to prevent the central bank from conjuring new money out of thin air and then distributing it directly into the bank accounts of every citizen.  Indeed, this is one of the points made by those who favour some form of Universal Basic Income as an alternative to the UK’s overly bureaucratic and increasingly ineffective social security system.  The reason that money is not created in this way is simply that channelling it through the banking and financial system favours the wealthy and powerful at the expense of the wider population.

Midway between the current practice of handing new money to the already wealthy – who get to enjoy it before inflation devalues it – and channelling it directly to the people, is the proposed creation of a national investment bank.  Whereas feeding new money to the already wealthy serves only to inflate asset bubbles in unproductive areas like property, fine art and collectibles, an investment bank could provide funding for national infrastructure development.  This, in turn, would provide new jobs as well as enhancing the productivity of the economy as a whole.

The only requirement of any of these forms of currency creation is that the government removes sufficient money from the economy through taxation to prevent inflation running out of control.  Herein, however, is the problem that has vexed governments down the ages.  Exactly how much money does the government need to remove from the economy to prevent inflation?

The current practice of giving new money to the already wealthy requires very little government action.  The central bank practice of raising interest rates is considered sufficient.  This is because, like taxes, debt repayment is a means of removing currency from the economy.  Just as banks create new currency when they make loans, so currency is destroyed when loans are repaid.  When the interest rate rises, an additional proportion of the currency in circulation has to be destroyed in order to pay the higher charge.

Once governments start moving new currency directly into the economy – either through investment banks or direct transfers to people’s bank accounts – taxation has to be adjusted accordingly in order to prevent the money supply growing too high and causing inflation.

The problem is that just as central banks cause financial crises by raising interest rates beyond the point where creditors begin to default; governments have a habit of causing crises by allowing too much new currency to be created.  It is all too easy for politicians – who need to get re-elected – to promise new investments in popular services – without thinking about the impact of that new spending on the broader economy.  In the 1970s, the impact of this kind of currency creation was so great that governments around the world handed control of their money supply to the banking sector; and passed legislation and entered into treaties (like Maastricht) that forbid direct government money printing (states are permitted to bail out banks, but not businesses or citizens).

The inflation of the 1970s is explained in economics textbooks as being the result of profligate governments playing fast and loose with their national economies.  The difficulty with that explanation, however, is that exactly the same money creation policies kick-started the greatest economic expansion the world has ever seen.  The post-war Marshall Aid programme which printed new dollars into existence in order to rebuild the shattered economies of Western Europe and Japan, together with the spending programme of Britain’s Labour government (which didn’t receive Marshall Aid), paved the way for the twenty-year boom 1953-73.  With western growth rates similar to those claimed by modern China, states using newly created currency to invest in and grow the economy became the economic orthodoxy for three decades.

If the supposed relationship between money printing and economic growth and crisis is beginning to sound like a false correlation to you, it is because it is.  It is what I refer to as “the Keynesian paradox.”

Having witnessed the austerity, depression and eventual rise of fascism in the aftermath of the First World War, economist John Maynard Keynes argued that the big mistake made in 1919 was for governments to return to the economic orthodoxy of the pre-war years.  This had resulted in austerity policies at home and the imposition of reparations on the defeated enemy.  What Keynes argued for was close to what the US delivered in 1945, when it realised its best protection against the Soviet Union was a prosperous, interconnected western bloc.

Keynes’ proposition was straightforward enough: if you give newly created money to a wealthy person, they will exchange it for some form of unproductive asset – a house, a piece of art, a vintage car, etc.  If, on the other hand, you give the same new money to a poor person, they will spend it all more or less immediately – on necessities like food, rent, fuel and clothing.  In this way, new currency distributed to the poor would quickly circulate around the economy; stimulating growth.

Keynes was correct in terms of money flows but wrong about growth.  Indeed, there was a period in European history – the years following the colonisation of the Americas – when a sudden influx of new money (in the form of the gold and silver shipped back to Spain) had exactly the opposite effect.  Without the influx of precious metals from the Americas, the Hapsburg Empire might have gone on to become the United States of Europe.  Instead, it experienced a prolonged and ruinous period of inflation that resulted in internal revolt and division.  In effect, the sudden influx of precious metals had the effect of devaluing the gold and silver (and money based upon it) already in circulation; manifesting as rapidly rising prices across the economy.

More recently, excessive money printing (in order to inflate away reparation debt) in Germany resulted in the runaway inflation of 1924 that helped propel Hitler and the Nazis onto the world stage.

This is the Keynesian Paradox.  An economic policy (Marshall Aid) that patently kick-started the largest economic boom in history, also created the inflation of the sixteenth century and the stagflation of the 1970s.

Might this suggest that there was some deeper factor common to sixteenth century Europe and the 1970s that was absent or opposite to conditions in the late 1940s?  What else happened in the 1970s?  The world experienced a major oil shock as US reserves were no longer sufficient to regulate global oil prices.  In the aftermath of the Second World War, global oil production grew exponentially; fuelling the boom.  That came to an end in 1973:

World oil production exponential-linear
Source: The Oil Drum/COS

In the period since 1973, oil production has continued to grow; but growth has been linear.  The result is that the rates of growth enjoyed in the west between 1953 and 1973 are never coming back.  Indeed, much of the oil we are adding to the mix today is expensive; giving it a much lower value to the economy than the oil being produced in the aftermath of the Second World War.

One of Keynes’ contemporaries – English Nobel Prize-winning chemist Frederick Soddy – understood this far better than Keynes:

“Still one point seemed lacking to account for the phenomenal outburst of activity that followed in the Western world the invention of the steam engine, for it could not be ascribed simply to the substitution of inanimate energy for animal labour. The ancients used the wind in navigation and drew upon water-power in rudimentary ways. The profound change that then occurred seemed to be rather due to the fact that, for the first time in history, men began to tap a large capital store of energy and ceased to be entirely dependent on the revenue of sunshine…

“Then came the odd thought about fuel considered as a capital store, out of the consumption of which our whole civilisation, in so far as it is modern, has been built. You cannot burn it and still have it, and once burnt there is no way, thermodynamically, of extracting perennial interest from it. Such mysteries are among the inexorable laws of economics rather than of physics. With the doctrine of evolution, the real Adam turns out to have been an animal, and with the doctrine of energy the real capitalist proves to be a plant. The flamboyant era through which we have been passing is due not to our own merits, but to our having inherited accumulations of solar energy from the carboniferous era, so that life for once has been able to live beyond its income. Had it but known it, it might have been a merrier age!”

The economic expansion that Soddy correctly attributed to the fossilised sunlight locked up in coal deposits was to be multiplied a hundredfold by the oil-based expansion that followed the Second World War.  And indeed, had we known that it was oil rather than one or other version of politics or economics that was responsible for our brief period of prosperity, our age too might have been merrier.

In this, the sixteenth century Europeans might have had something to tell us; because they also experienced an energy crisis.  Given that this was a period when economies ran entirely on renewable energy, there is a corrective here too for those who imagine that returning to some pre-industrial idyll might be our salvation.  Sixteenth century Europeans chopped down their forests at a much faster rate than the trees could be regrown.  As historian Clive Ponting notes:

“A timber shortage was first noticed in Europe in specialised areas such as shipbuilding… In the 1580s when Philip II of Spain built the armada to sail against England and the Dutch had to import timber from Poland… Local sources of wood and charcoal were becoming exhausted – given the poor state of communications and the costs involved it was impossible to move supplies very far.  As early as 1560 the iron foundries of Slovakia were forced to cut back production as charcoal supplies began to dry up.  Thirty years later the bakers of Montpellier in the South of France had to cut down bushes to heat their ovens because there was no timber left in their town…”

Creating new currency – in this case the new precious metals from the Americas – into an economy that has outrun its energy supplies could only result in inflation because without sufficient energy there could be no economic growth.  Only when new sources of energy – in this case, coal from the Severn Valley – can be brought into production does the economy recover and a new round of economic growth begin.

When western states printed new currency into existence to rebuild their war-torn economies in the years after 1945, they did so while almost all of the planet’s oil deposits were still in the ground.  Much of the new currency was invested into economic activities that required oil for manufacture and/or transportation.  That, in turn, meant that a proportion of the new currency found its way into the accounts of the big oil companies; who used it to open up the vast oil reserves around the planet.  It was this cheap, abundant reserve of oil that allowed for massive currency creation without generating inflation.  It was precisely at the point when money creation overshot oil production that the inflation of the 1970s set in.

Fast-forward to the very different world of 2018: World production of “conventional” crude oil peaked in 2005.  The resulting inflation – followed by the inevitable interest rate rises – triggered the worst financial collapse in living memory.  Oil production is still, just about, increasing; but only at great expense.  Low quality and expensive oil from fracking, tar sands and ultra-deep water is keeping the economy going; but only at the cost of obliging us – businesses and households – to devote a greater part of our income to energy (either directly or through the energy embodied in the goods and services we purchase).

Unlike money trees, there is nothing magical about oil (which, a handful of electric cars aside, still powers almost all of our agricultural, industrial and transportation vehicles and machinery).  Even now, there is more oil beneath the ground than we have used so far.  But most of what is left is going to stay in the ground simply because it is too expensive (i.e. it requires too much energy) to extract.

Alternative energy sources do not really exist, other than by sleight of hand.  Most often, this is done simply by conflating electricity with energy.  But the crisis we face is primarily a liquid fuel crisis.  As such, the electrical energy generated by a wind turbine or a nuclear plant is irrelevant.  What has actually happened has nothing to do with ending our use of fossil fuels.  Rather, states around the world have turned to alternative fossil fuels – coal and gas – together with renewables and nuclear to free up the remaining extractable oil for use in industry, agriculture and transportation.  Oil consumption, however, continues to rise, because without it growth would end and the mountain of debt-based currency would collapse around our ears.

This brings us back to the money question.  There is a growing belief that the solution to our problems will come in the form of a switch from austerity economics to an expansionary policy based on distributing newly created currency via investment banks and/or universal basic incomes.  This, however, is highly unlikely to succeed until or unless we find a means of massively increasing the energy available (at the point of use) to the economy to counteract the decline in affordable oil that is beginning to emerge (replacing unaffordable oil with unaffordable renewables doesn’t really count).

Politically, the demand for an end to austerity is becoming irresistible.  We already see its manifestation in Brexit, the election of Donald Trump and the rise of populist (right and left) parties across Europe.  Around the world, the people have put the elites on notice that they will no longer tolerate an economy in which a tiny handful of kleptocrats continue to accumulate wealth via a rigged financial system while everyone else sees their standard of living plummet.

The mistake, however, would be to assume that simply printing currency will solve the problem.  Without useable energy to back it up, new currency is worthless.  Its only role is to steal a fraction of all of the currency already in circulation.  This may have small benefits if channelled to ordinary people, since it will be the accumulated currency of the wealthy that is devalued the most – a kind of hidden tax.  But the ensuing price increases are far more likely to be experienced by those at the bottom of the income scale; as their ability to pay for necessities is rapidly eroded.

The crisis of our age, then, is not to pick the fruit of the magic money tree; but to discover the location of the magic energy tree whose fruit has fertilised the money tree for the past 250 years.  Sadly, that magic (fossilised sunlight) energy tree has shrivelled with age.  We may never see its like again.





China is in trouble….

12 06 2018

Between yesterday’s revelation of Saudi Arabia’s appointment with 2030 and now this, the global economy is looking ever more shaky….
Republished from MISES WIRE..
06/09/2018

Before we discuss the economic situation of China, a few words about China’s strongman, Xi Jinping. The “new Chinese emperor” has engineered a meteoric rise. He started off as simple rural laborer but is now the most powerful Chinese president since Deng Xiaoping. Such a career path requires strength, tact, and probably a dash of unscrupulousness. 

While the rulers of China have been able all along to hedge their plans over longer periods than their Western counterparts have, the new legal situation has extended this planning horizon even further.1 In comparison with those of Western economies, China’s countermeasures against the crisis in 2008 were significantly more drastic. While in the US the balance sheet total of the banking system increased by USD 4,000bn in the years after the global financial crisis, the balance sheet of the Chinese banking system expanded by USD 20,000bn in the same period. For reference: This is four times the Japanese GDP.

increm-China-1.png

The following chart shows the expansion of the bank balance sheet total as compared to economic output. Did the Chinese authorities assume excessive risks in fighting the crisis?

increm-China-2.png

Neither the fact that China’s bank balance sheets amount to more than 600% of GDP nor the fact that they have doubled in terms of percentage of GDP in the past several years suggests a healthy development. Our friends from Condor Capital expect NPL ratios51F to rise in China, which could translate into credit losses of USD 2,700 to 3,500bn for China’s banks, and this is under the assumption of no contagion (!). By comparison, the losses of the global banking system since the financial crisis have been almost moderate at USD 1,500bn

The most recent crisis does teach us, however, that the Chinese are prepared to take drastic measures if necessary. China fought the financial crisis by flooding the credit markets: 35% credit growth in one year on the basis of a classic Keynesian spending program is no small matter.

increm-China-3.png

Chinese money not only inflates a property bubble domestically but also around the globe (e.g. in Sydney and Vancouver). Further support for the global property markets is in question, given the measures China has recently launched. Due to financial problems, Chinese groups such as Anbang and HNA will have to swap the role of buyer for that of seller.

The IMF has forecast a further doubling of total Chinese debt outstanding from USD 27,000bn in 2016 to USD 54,000bn in 2022. By comparison, in 2016 China’s GDP amounted to USD 11,200bn. This spells debt-induced growth at declining rates of marginal utility. From our point of view, this development – which we can also see in the West – is unsustainable.

increm-China-4.png

In its most recent report, “Credit Booms – Is China different?”, the IMF states that in 43 cases worldwide of strong credit growth (i.e. the ratio of credit to GDP grows more than 30% over five years), only five cases ended up without a significant slowdown or a financial crisis. The IMF also points out that no expansion of credit that started at a debt to GDP ratio above 100% of GDP ended well. It is worth noting that China has a high percentage of domestic as opposed to foreign debt, which definitely makes matters easier for the country. But the question is: Will it be different for China this time?

The 19th-century Opium Wars that China fought with England, which are deeply rooted within the collective memory of the Chinese people, are historical events that are of great importance in connection with the punitive tariffs imposed by the US, as they remain a fixed and integral part of the Chinese history curriculum in schools.2 If necessary, China could stir up anti-Western sentiment in order to implement measures that are hard on its own population, even if they are unpopular. The buck would of course stop with the Americans. Thus, the US could shoot itself in the foot with any escalation of the trade war, as we regard the ability to bear hardships and the cohesion of Chinese society as much stronger than those of the American society.

The demographic development of China is also worth a quick sidebar. The World Bank forecasts a population peak of 1.4bn for China in 2028. The decline in population that is predicted to set in around that time should proceed at a similar pace as the increase towards the peak.

increm-China-5.png

The fit-for-work population (aged 16 to 59) has been decreasing since 2012 and is expected to decline by almost 25% to 700mn by 2050. Thus China, much like the West, has the problem of an aging population.

increm-China-6.png

Conclusion

Unlike his Western competitors, China’s new strongman, Xi, can implement his long-term strategy in a targeted and gradual fashion. Xi explicitly underlined his goal of asserting China’s interests in the world by referring to military, economic, political, and diplomatic means in his speech at the National Congress in October 2017.3 He left no doubt that China was not willing to compromise in any shape or form with regard to its territorial integrity (N.B. Taiwan, Hong Kong, Tibet), and he issued point-blank threats against separatist tendencies.

However, the transformation of the economy could (intentionally or otherwise) cause economic distortions not only in China but globally. Recent years have been dominated by a massive expansion of credit. In fact, it is often said that China has blown the biggest credit bubble in history.

It seems, there are greater similarities between China and the US than may be visible at first glance. China builds real estate for a shrinking population, invests for an overindebted client (the US, which even insists on a drastic reduction of the bilateral trade deficit) and finances all this with money it does not have.4

  • 1.An analogy from the field of sports: The national sport of the USA is baseball; in China, it is Go. The approach to foreign politics is similar: The Americans are known for their short-term “hit and run” foreign policy, whereas the Chinese play the long game in their foreign policy and are very difficult to read in doing so.
  • 2.Recommended reading: The Opium Wars, by Julia Lovell
  • 3.http://www.bbc.com/news/world-asia-china-43466685
  • 4.A paraphrase of the famous quote from “Fight Club”: “We buy things we don’t need with money we don’t have to impress people we don’t like.”

Ronald-Peter Stöferle is managing partner and fund manager at Incrementum AG, Liechtenstein. He invests using the principles of the Austrian school of economics.





I told you so………

15 03 2018

At this rate, it’s going to take nearly 400 years to transform the energy system

Here are the real reasons we’re not building clean energy anywhere near fast enough.

“Is it possible to accelerate by a factor of 20?” he asks. “Yeah, but I don’t think people understand what that is, in terms of steel and glass and cement.” 

by James Temple  Originally published at Technology Review

windhelicopter

Fifteen years ago, Ken Caldeira, a senior scientist at the Carnegie Institution, calculated that the world would need to add about a nuclear power plant’s worth of clean-energy capacity every day between 2000 and 2050 to avoid catastrophic climate change. Recently, he did a quick calculation to see how we’re doing.

Not well. Instead of the roughly 1,100 megawatts of carbon-free energy per day likely needed to prevent temperatures from rising more than 2 ˚C, as the 2003 Science paper by Caldeira and his colleagues found, we are adding around 151 megawatts. That’s only enough to power roughly 125,000 homes.

At that rate, substantially transforming the energy system would take, not the next three decades, but nearly the next four centuries. In the meantime, temperatures would soar, melting ice caps, sinking cities, and unleashing devastating heat waves around the globe (see “The year climate change began to spin out of control”).

Caldeira stresses that other factors are likely to significantly shorten that time frame (in particular, electrifying heat production, which accounts for a more than half of global energy consumption, will significantly alter demand). But he says it’s clear we’re overhauling the energy system about an order of magnitude too slowly, underscoring a point that few truly appreciate: It’s not that we aren’t building clean energy fast enough to address the challenge of climate change. It’s that—even after decades of warnings, policy debates, and clean-energy campaigns—the world has barely even begun to confront the problem.

The UN’s climate change body asserts that the world needs to cut as much as 70 percent of greenhouse-gas emissions by midcentury to have any chance of avoiding 2 ˚C of warming. But carbon pollution has continued to rise, ticking up 2 percent last year.

So what’s the holdup?

Beyond the vexing combination of economic, political, and technical challenges is the basic problem of overwhelming scale. There is a massive amount that needs to be built, which will suck up an immense quantity of manpower, money, and materials.

For starters, global energy consumption is likely to soar by around 30 percent in the next few decades as developing economies expand. (China alone needs to add the equivalent of the entire US power sector by 2040, according to the International Energy Agency.) To cut emissions fast enough and keep up with growth, the world will need to develop 10 to 30 terawatts of clean-energy capacity by 2050. On the high end that would mean constructing the equivalent of around 30,000 nuclear power plants—or producing and installing 120 billion 250-watt solar panels.

Energy overhaul
What we should be doing* What we’re actually doing
Megawatts per day 1,100 151
Megawatts per year 401,500 55,115
Megawatts in fifty years 20,075,000 2,755,750
Years to add 20 Terrawatts 50 363
Sources: Carnegie Institution, Science, BP *If we had started at this rate in 2000 Actual average rate of carbon-free added per day from 2006-2015

There’s simply little financial incentive for the energy industry to build at that scale and speed while it has tens of trillions of dollars of sunk costs in the existing system.

“If you pay a billion dollars for a gigawatt of coal, you’re not going to be happy if you have to retire it in 10 years,” says Steven Davis, an associate professor in the Department of Earth System Science at the University of California, Irvine.

It’s somewhere between difficult and impossible to see how any of that will change until there are strong enough government policies or big enough technology breakthroughs to override the economics.

A quantum leap

In late February, I sat in Daniel Schrag’s office at the Harvard University Center for the Environment. His big yellow Chinook, Mickey, lay down next to my feet.

Schrag was one of President Barack Obama’s top climate advisors. As a geologist who has closely studied climate variability and warming periods in the ancient past, he has a special appreciation for how dramatically things can change.

Sitting next to me with his laptop, he opened a report he had recently coauthored assessing the risks of climate change. It highlights the many technical strides that will be required to overhaul the energy system, including better carbon capture, biofuels, and storage.

The study also notes that the United States adds roughly 10 gigawatts of new energy generation capacity per year. That includes all types, natural gas as well as solar and wind. But even at that rate, it would take more than 100 years to rebuild the existing electricity grid, to say nothing of the far larger one required in the decades to come.

“Is it possible to accelerate by a factor of 20?” he asks. “Yeah, but I don’t think people understand what that is, in terms of steel and glass and cement.”

Climate observers and commentators have used various historical parallels to illustrate the scale of the task, including the Manhattan Project and the moon mission. But for Schrag, the analogy that really speaks to the dimensions and urgency of the problem is World War II, when the United States nationalized parts of the steel, coal, and railroad industries. The government forced automakers to halt car production in order to churn out airplanes, tanks, and jeeps.

The good news here is that if you direct an entire economy at a task, big things can happen fast. But how do you inspire a war mentality in peacetime, when the enemy is invisible and moving in slow motion?

“It’s a quantum leap from where we are today,” Schrag says.

The time delay

The fact that the really devastating consequences of climate change won’t come for decades complicates the issue in important ways. Even for people who care about the problem in the abstract, it doesn’t rate high among their immediate concerns. As a consequence, they aren’t inclined to pay much, or change their lifestyle, to actually address it. In recent years, Americans were willing to increase their electricity bill by a median amount of only $5 a month even if that “solved,” not eased, global warming, down from $10 15 years earlier, according to a series of surveys by MIT and Harvard.

It’s conceivable that climate change will someday alter that mind-set as the mounting toll of wildfires, hurricanes, droughts, extinctions, and sea-level rise finally forces the world to grapple with the problem.

But that will be too late. Carbon dioxide works on a time delay. It takes about 10 years to achieve its full warming effect, and it stays in the atmosphere for thousands of years. After we’ve tipped into the danger zone, eliminating carbon dioxide emissions doesn’t decrease the effects; it can only prevent them from getting worse. Whatever level of climate change we allow to unfold is locked in for millennia, unless we develop technologies to remove greenhouse gases from the atmosphere on a massive scale (or try our luck with geoengineering).

This also means there’s likely to be a huge trade-off between what we would have to pay to fix the energy system and what it would cost to deal with the resulting disasters if we don’t. Various estimates find that cutting emissions will shrink the global economy by a few percentage points a year, but unmitigated warming could slash worldwide GDP more than 20 percent by the end of the century, if not far more.

In the money

Arguably the most crucial step to accelerate energy development is enacting strong government policies. Many economists believe the most powerful tool would be a price on carbon, imposed through either a direct tax or a cap-and-trade program. As the price of producing energy from fossil fuels grows, this would create bigger incentives to replace those plants with clean energy (see “Surge of carbon pricing proposals coming in the new year”).

“If we’re going to make any progress on greenhouse gases, we’ll have to either pay the implicit or explicit costs of carbon,” says Severin Borenstein, an energy economist at the University of California, Berkeley.

But it has to be a big price, far higher than the $15 per ton it cost to acquire allowances in California’s cap-and-trade program late last year. Borenstein says a carbon fee approaching $40 a ton “just blows coal out of the market entirely and starts to put wind and solar very much into the money,” at least when you average costs across the lifetime of the plants.

Others think the price should be higher still. But it’s very hard to see how any tax even approaching that figure could pass in the United States, or many other nations, anytime soon.

The other major policy option would be caps that force utilities and companies to keep greenhouse emissions below a certain level, ideally one that decreases over time. This regulations-based approach is not considered as economically efficient as a carbon price, but it has the benefit of being much more politically palatable. American voters hate taxes but are perfectly comfortable with air pollution rules, says Stephen Ansolabehere, a professor of government at Harvard University.

Fundamental technical limitations will also increase the cost and complexity of shifting to clean energy. Our fastest-growing carbon-free sources, solar and wind farms, don’t supply power when the sun isn’t shining or the wind isn’t blowing. So as they provide a larger portion of the grid’s electricity, we’ll also need long-range transmission lines that can balance out peaks and valleys across states, or massive amounts of very expensive energy storage, or both (see “Relying on renewables alone significantly inflates the cost of overhauling energy”).

Million tonnes oil equivalentA renewables revolution?Despite the wide optimism surrounding renewables like wind and solar, they still only represent atiny and slow growing fraction of global energy.NuclearHydroAll RenewablesCoalNatural GasOil2000200120022003200420052006200720082009201020112012201320142015201605k10k15kSource: World consumption of primary energy consumption by source. BP

The upshot is that we’re eventually going to need to either supplement wind and solar with many more nuclear reactors, fossil-fuel plants with carbon capture and other low-emissions sources, or pay far more to build out a much larger system of transmission, storage and renewable generation, says Jesse Jenkins, a researcher with the MIT Energy Initiative. In all cases, we’re still likely to need significant technical advances that drive down costs.

All of this, by the way, only addresses the challenge of overhauling the electricity sector, which currently represents less than 20 percent of total energy consumption. It will provide a far greater portion as we electrify things like vehicles and heating, which means we’ll eventually need to develop an electrical system several times larger than today’s.

But that still leaves the “really difficult parts of the global energy system” to deal with, says Davis of UC Irvine. That includes aviation, long-distance hauling, and the cement and steel industries, which produce carbon dioxide in the manufacturing process itself. To clean up these huge sectors of the economy, we’re going to need better carbon capture and storage tools, as well as cheaper biofuels or energy storage, he says.

These kinds of big technical achievements tend to require significant and sustained government support. But much like carbon taxes or emissions caps, a huge increase in federal research and development funding is highly unlikely in the current political climate.

Give up?

So should we just give up?

There is no magic bullet or obvious path here. All we can do is pull hard on the levers that seem to work best.

Environmental and clean-energy interest groups need to make climate change a higher priority, tying it to practical issues that citizens and politicians do care about, like clean air, security, and jobs. Investors or philanthropists need to be willing to make longer-term bets on early-stage energy technologies. Scientists and technologists need to focus their efforts on the most badly needed tools. And lawmakers need to push through policy changes to provide incentives, or mandates, for energy companies to change.

The hard reality, however, is that the world very likely won’t be able to accomplish what’s called for by midcentury. Schrag says that keeping temperature increases below 2 ˚C is already “a pipe dream,” adding that we’ll be lucky to prevent 4 ˚C of warming this century.

That means we’re likely to pay a very steep toll in lost lives, suffering, and environmental devastation (see “Hot and violent”).

But the imperative doesn’t end if warming tips past 2 ˚C. It only makes it more urgent to do everything we can to contain the looming threats, limit the damage, and shift to a sustainable system as fast as possible.

“If you miss 2050,” Schrag says, “you still have 2060, 2070, and 2080.”





The Selfish Green

14 01 2018

Every now and again, a video pops up in my newsfeed that I really really look forward to watching. This was one of them…… but oh what a disappointment…..  Sometimes, and I know I am not, I start believing I am the only one who ‘gets it’ and sees the whole picture. Well 99% of it, I’m certain I’ve missed something.

While there’s no doubting the eminence of the panel of four, David Attenborough, Richard Dawkins, Jane Goodall, and Richard Leaky (of whom I hadn’t really heard of much before…), I thought they fell far short of understanding the issues – no, predicaments – we are facing.  None of them seem to know much about energy, or the monetary system, with the fat cat lookalike, that Leaky fellow I didn’t know much about, really displaying his ignorance of nuclear energy.

What’s plain to see after watching that lot is that we are truly stuffed, notwithstanding their collective optimism, which as you probably all know, I don’t share……  a pessimist is, after all, a well informed optimist…!

Leaky’s wish to monetise every aspect of the environment so it can be saved really takes the cake. Money is the problem after all, which thankfully Attenborough points out to him, even if it’s just as an aside.  I love Jane Goodall to bits (and her chimps – there’s a wonderful clip of a couple with a Jack in the Box), but she’s frankly a bit naïve.  Dawkins is interesting, as always, but has no grasp of the financial and energy problems at all, in fact says nothing whatever about it.  Attenborough is the best informed of all, he has after all seen how the planet has changed in the past 60 years more than anyone else, and at least he realises we are way overpopulated……..  at the end, they all roll around in hopium. I’d love to know what DTM followers think……

That this video has only had 187,634 views as I type says it all.  Does anybody care?

 





More on money and the economy………

11 11 2017

Articles that, as far as I am concerned, confirm my desire to print local money are coming into my newsfeed thick and fast. This latest one, from the consciousness of sheep, claims the UK economy is as good as finished…….

I don’t agree with everything in it, but bear with me…..

This article also ties in with the looming oil problems. Of course, with the North Sea oil fields depleting in double digits figures, and the UK being as good as out of coal and gas, it’s no wonder an English website would be expressing concern. Make no mistake though, with Australia importing well over 90% of all its liquid fuel requirements, we are in no better shape, really….

“Inflation” says the author “results in the appearance of rising prices; but is actually the devaluation of money.” In my opinion, this is one of the biggest mistakes of economics. Money has no value. It’s for trading and spending. When we sold our house a couple of years ago, we were suddenly the owners of $400,000 instead of a house. Were we rich? I don’t think so…….  not until we spent it on a farm, a couple of utes, a bunch of tools, building materials, livestock, soil improvers, earthworks, concrete…… and now most of the money is gone, I feel richer than ever, because I have the things I need to face our uncertain future. No I’ll take that back, the future is certain, it will be bad…!

There are, however, other reasons for rising prices [than money printing].  And unlike monetary inflation, these are self-correcting.  For example, global oil prices have begun to break out of the $40-$60 “goldilocks” band in which consumers and energy companies can just about keep their heads above water.  Most economists believe this to be dangerously inflationary.  Indeed, almost all previous recessions are the result of monetary tightening (usually by raising interest rates) in response to an upward spike in oil prices.  Since oil is used to manufacture and/or transport every item that we buy, if the price of oil increases, then the price of everything else must increase too.

But the price of oil is not increasing in response to money printing.  Rather, it is the result of declining inventories which point to a global shortage of oil early in 2018 – traders are currently bidding up the price on futures contracts to guarantee access to sufficient oil to meet anticipated demand.  Since oil is considered “inelastic” (we have little choice but to pay for it) the assumption is that rising wholesale prices will be passed on to consumers, causing general inflation.  Frank Shostak from the Mises Institute challenges this assumption:

“Whether the asking price set by producers is going to be realized in the market place, however, hinges on whether or not consumers will accept those prices. Consumers dictate whether the price set by producers is ‘right’.  On this Mises wrote, ‘The consumers patronize those shops in which they can buy what they want at the cheapest price. Their buying and their abstention from buying decides who should own and run the plants and the farms. They determine precisely what should be produced, in what quality, and in what quantities.’

“If consumers don’t have the money to support the prices asked by producers then the prices asked cannot be realized.”

And the result is a recession/depression……. Shostak further argues that in this case:

“If the price of oil goes up and if people continue to use the same amount of oil as before, then this means that people are now forced to allocate more money for oil. If people’s money stock remains unchanged then this means that less money is available for other goods and services, all other things being equal. This of course implies that the average price of other goods and services must come off.”

Clearly there is a difference between something as ubiquitous as oil and those other goods and services that must fall in price unless more money is printed into existence.  The difference is this; each of us has a series of “non-discretionary” purchases that we have little or no choice but to make every month.  These include:

  • Rent/mortgage payments
  • Utility bills
  • Debt interest
  • Council tax
  • Food
  • Transport
  • Telephone/broadband

In addition, we make various “discretionary” purchases of goods and services that we want rather than need.  These include pretty much everything else that we buy, including:

  • TV subscriptions
  • Cinema
  • Eating out
  • Going to the pub
  • Music downloads/subscriptions
  • Electrical equipment
  • Clothes
  • Home furnishings

Oddly enough…..  I have nothing to do with that last list! Am I already out of discretionary spending power…?

If the cost of living rises without appropriate increases in people’s access to money, then we as individuals do what governments are trying to do to the economy as a whole – we cut back on everything that we consider discretionary.  In this way, the rising price of oil – and electricity -does not result in generalised inflation; it merely redistributes our spending across the economy. Just ask the retail sector how well it’s doing at the moment….. When I recently replaced my freezer for a bigger one, I went to Gumtree, not Hardly Normal, and the perfectly functioning small freezer will be sold to pay for it.

This is of course where ‘free money’ from the community, to only be spent in the community really comes in handy. It allows people to buy their essentials, when locally made, without spending the government money, thus allowing the real stuff to be spent on energy and taxes and other stuff created in the Matrix.

Make no mistake, one day soon, the ONLY economy left will be our local economies.

The articles continues…….

Another mistake made by economists and politicians is the belief that rising prices will generate political pressure for additional public spending and for wage increases across the economy.  Indeed, one of the greatest economic mysteries of our age is why apparently full employment has failed to translate into rising wages.  The obvious answer, of course, is that working people have traded employment for low wages.

There is good reason for this.  Since 2010, government attempts to run a budget surplus have sucked money out of the economy.  Public spending and social security payments (the two ways new government money enter the economy) have been savagely cut.  If government refuses to spend new money into the economy, only the banks can.  But since 2008 the banks have stubbornly refused to spend money into the “real economy,” preferring instead to pump up asset bubbles that add no new value to the wider economy.  Only those working people fortunate enough to get a foot on the housing ladder get to benefit from this; but even they can see the illusion – a house may have risen in price since it was bought… but it is still the same house; no commensurate additional value has been added.  The same is true for bubbles in bonds, shares, cryptocurrencies, luxury property, collectibles and fine art.

“Full employment”? The writer seems unaware of the manipulation of statistics regarding employment… don’t know if the UK suffers from the same problem, but here in Australia, anyone working just one hour a week is no longer considered unemployed! A remarkable nmber of people ‘on the dole’ actually work, they are merely underemployed, but not counted.

And the way governments have stopped spending in vain attempts to reach budget surpluses is truly baffling. As is of course the tsunami of privatizations going on all over the world. This wealth transfer is the biggest con the planet has ever seen…

Economically, people are responding to this in the only way they can.  The working poor – increasingly dependent upon in-work benefits and foodbanks – have not only cut their discretionary spending; they have been eating into their supposedly non-discretionary spending too.  As Jamie Doward in the Guardian reports:

“More than a third of people who earn less than the “real living wage” have reported regularly skipping meals to save money…  A poll carried out for the Living Wage Foundation also found that more than a third of people earning less than this had topped up their monthly income with a credit card or loan in the last year, while more than one in five reported using a payday loan to cover essentials. More than half – 55% – had declined a social invitation due to lack of money, and just over half had borrowed money from a friend or relative.”

As I’ve said in past posts on this issue, if you don’t have access to money, you simply have to borrow it. Credit card debt in Australia accounts for a full quarter of all private debt, and when you have to pay extortionary interest rates on those, it limits your spending power even more.

Things look grim in the UK it seems….

Cat Rutter Pooley in the Financial Times reports that:

“In-store sales of non-food items fell 2.9 per cent over the three months to October and 2.1 per cent in the past year — the worst performance since the BRC started compiling the data in January 2012. Clothing sales were particularly hard hit, according to the report, with unseasonably warm weather holding down purchases. Online sales growth was also lacklustre, at less than half the pace of the three- and 12-month averages.”

This latter point is particularly important because until now economists and politicians have peddled the myth that high street sales were falling because consumers were buying online.  The reality is that they are falling because – with the exception of food – we are not buying anymore.  The news of the fall in high street shopping comes just a day after the British Beer and Pub Association reported a massive fall in the sale of beer.  On the same day, energy company SSE threatened to shut down its energy supply business as a result of falling profits.  Back in December last year, we reported a similar shift in purchasing behaviour as people cut back on personal hygiene products.

You know things are bad when beer sales are falling…! If ever there was an argument to be made for self sufficiency, this does the job. I make 90% of the alcohol I drink (and it isn’t much, believe me… my wife gave me a bottle of Scotch when I left Queensland for good two years ago, and the bottle was only recently emptied..); and I am finally growing more and more of my own food, even selling excess produce I cannot eat fast enough myself…  Nicole Foss’ deflationary spiral sounds like it’s started, and while no one is saying so yet, I think it’s on in Australia too.

The one consolation is that when Britain’s poor have finally cut their spending to the bone, and a swathe of businesses have been forced into bankruptcy, it is the rich who are going to face the biggest losses.  The Positive Money campaign highlights the Bank of England/Treasury dilemma:

“The Bank of England faces its current predicament thanks to an ongoing failure to think beyond a limited, orthodox form of the central bank’s role. By keeping rates low, it risks inflating asset bubbles even further. But with incomes so weak, now is the wrong time to raise them.”

This lesson will only be learned retrospectively.  Once it becomes apparent that millions of British workers are not going to be repaying their debts, banks will crash.  Once it becomes apparent that British workers cannot provide the government with the tax income to pay back its borrowing, the bond market will crash.  Ironically, JPMorgan has already christened the coming collapse; as Joe Ciolli at Business Insider reported last month:

“JPMorgan has already coined a nickname for the next financial meltdown.  And while the firm isn’t sure exactly when the so-called Great Liquidity Crisis will strike, it figures that tensions will start to ratchet up in 2018…”

And I thought 2020 would be crunch time…….. how often can I be called an optimist..??

When the time comes, Britain will be particularly badly hit because our economy has been all but hollowed out.  The supposed “wealth” that makes up a large part of our GDP comes from the movement of precisely the asset classes that the coming Great Liquidity Crisis will render worthless.  The difference compared to 2008 is that this time around the banks are too big to save and individual central banks and governments are too small to save them.

Limits to growth, limits everywhere….. and nobody’s acknowledging it.

 





I’m not the only one who’s worked it out….

7 11 2017

Following up on the post where I ‘claimed’ to have worked it out, along comes this article from a website I recently discovered that all my readers should also follow. Dr Tim Morgan who runs the WordPress blog Surplus Energy Economics, published the following, called Anticipating the next crash. While he doesn’t exactly mention printing one’s own community money, every single argument he makes proves my point as far as I am concerned…… the loss of trust in money in particular really caught my attention…..

Enjoy….

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

THIS TIME IT COULD BE MONEY – NOT BANKS

tim morganBecause the global financial crisis (GFC) was caused by a collapse of trust in banks, it can be all too easy to assume that the next crash, if there is one, must take the same form.

In fact, it’s more likely to be different. Whilst the idiocy-of choice before 2008 had been irresponsible lending, by far the most dangerous recklessness today is monetary adventurism.

So it’s faith in money, rather than in banks, that could trigger the next crisis.

Introduction – mistaken confidence

Whenever we live through a traumatic event, such as the GFC of 2008, the authorities ‘close the stable door after the horse has bolted’. They put in place measures that might have countered the previous crisis, if only they had they known its nature in advance.

The reason why such measures so often fail to prevent another crash is simple – the next crisis is never the same as the last one.

That’s where we are now. We might be slightly better-placed to combat a GFC-style event today than we were back in 2008, though even that is doubtful. But we are dangerously ill-prepared for what is actually likely to happen.

Put at its simplest, the GFC resulted from the reckless accumulation of debt over the previous 8-10 years. Debt creation has continued – indeed, accelerated – since 2008, but the new form of recklessness has been monetary adventurism.

So it’s likely to be money, not debt, which brings the house down this time. Where 2008 was triggered by a collapse of faith in banks, a loss of faith in currencies could be the trigger for the next crisis.

And, judging by their actions, the authorities seem not to have spotted this risk at all.

Unfinished business?

Where the likelihood of a sequel to 2008 is concerned, opinion divides into two camps.

Some of us are convinced that the GFC is unfinished business – and that another crisis has been made more likely by the responses adopted back then. That we’re in a minority shouldn’t worry us because, after all, change happens when the majority (‘consensus’) view turns out to be wrong.

Others, probably the majority, believe that normality has now been restored.

But this view, frankly, is illogical. To believe that what we have now is “normality”, you would have to accept each of these propositions as true.

1. Current monetary conditions, with interest rates that are negative (lower than inflation), are “normal”

2. It is “normal” for people to be punished for saving, but rewarded for borrowing

3. It is also “normal” for debt to be growing even more rapidly now than it did before 2008

4. Buying $1 of “growth” with $3 or more of borrowing is “normal”

5. QE – the creation of vast sums of new money out of thin air – is also “normal”

6. Vastly inflated asset values, and extremely depressed incomes, are “normal”

7. Policies which hand money to the already-wealthy, at the expense of everyone else, are another aspect of “normal”

8. It is quite “normal” for us to have destroyed the ability to save for pensions, or for any other purpose.

To be sure, Lewis Carroll’s White Queen famously managed to believe “six impossible things before breakfast”, but even she would have struggled to swallow this lot with her croissants and coffee.

When we consider, also, the continued stumbling global economy – which, nearly a decade after the crisis, remains nowhere near “escape velocity” – the case for expecting a second crash becomes pretty compelling.

But this does not mean that we should expect a re-run of 2008 in the same form.

Rather, everything suggests that the sequel to 2008 will be a different kind of crisis. The markets won’t be frightened by something familiar, but will be panicked by something new.

This means that we should expect a form of crisis that hasn’t been anticipated, and hasn’t been prepared for.

2008 – a loss of trust in banks

We need to be clear that the GFC had two real causes, both traceable in the last analysis to reckless deregulation.

First, debt had escalated to unsustainable levels.

Second, risk had proliferated, and been allowed to disperse in ways that were not well understood.

Of these, it was the risk factor which really triggered the crash, because nobody knew which banks and other financial institutions were safe, and which weren’t. This put the financial system into the lock-down known as “the credit crunch”, which was the immediate precursor to the crash.

Ultimately, this was all about a loss of trust. Even a perfectly sound bank can collapse, if trust is lost. Because banks are in the business of borrowing short and lending long, there is no way that they can call in loans if depositors are panicked into pulling their money out.

This also means – and please be in no doubt about this – that there is no amount of reserves which can prevent a bank collapse.

So – and despite claims to the contrary – a 2008-style banking crisis certainly could take place again, even though reserve ratios have been strengthened. This time, though, banks are likely to be in the second wave of a crash, not in the front line.

Coming next – a loss of trust in money?

The broader lesson to be learned from the financial crisis is that absolute dependency on faith is by no means unique to banks.

Trust is a defining characteristic of the entire financial system – and is particularly true of currencies.

Modern money, not backed by gold or other tangible assets, is particularly vulnerable to any loss of trust. The value of fiat money depends entirely on the “full faith and credit” of its sponsoring government. If that faith and creditworthiness are ever called into serious question, the ensuing panic can literally destroy the value of the currency. It’s happened very often in the past, and can certainly happen again.

Loss of faith in a currency can happen in many ways. It can happen if the state, or its economy, become perceived as non-viable. In fact, though, this isn’t the most common reason for currency collapse. Rather, any state can imperil the trustworthiness of its currency if it behaves irresponsibly.

Again, we can’t afford to be vague about this. Currency collapse, resulting from a haemorrhaging of faith, is always a consequence of reckless monetary policy. Wherever there is policy irresponsibility, a currency can be expected to collapse.

In instances such as Weimar Germany and modern-day Zimbabwe, the creation of too much money was “route one” to the destruction of the trust. But this isn’t the only way in which faith in a currency can be destroyed. Another trust-destroying practice is the monetizing of debt, which means creating money to “pay” government deficits.

So the general point is that the viability of a currency can be jeopardized by any form of monetary irresponsibility. The scale of risk is in direct proportion to the extent of that irresponsibility.

The disturbing and inescapable reality today is that the authorities, over an extended period, have engaged in unprecedented monetary adventurism. As well as slashing interest rates to levels that are literally without precedent, they have engaged in money creation on a scale that would have frightened earlier generations of central bankers out of their wits.

Let’s be crystal clear about something else, too. Anyone who asserts that this adventurism isn’t attended by an escalation in risk is living in a fantasy world of “this time it’s different”.

Here is a common factor linking 2008 and 2017. In the years before the GFC, reckless deregulation created dangerous debt excesses. Since then, recklessness has extended from regulation into monetary policy itself. Now, as then, irresponsible behaviour has been the common factor.

A big difference between then and now, though, lies in the scope for recovery. In 2008, the banks could be rescued, because trust in money remained. This meant that governments could rescue banks by pumping in money. There exist few, if any, conceivable responses that could counter a haemorrhage of faith in money.

Obviously, you can’t rescue a discredited currency by creating more of it. [ED. hence the need to create local currency]

If a single currency loses trust, another country or bloc might just bail it out. But even this is pretty unlikely, because of both sheer scale, and contagion risk.

So there is no possible escape route from a systemic loss of trust in fiat money. In that situation, the only response would be to introduce wholly new currencies which start out with a clean bill of health.

An exercise in folly

To understand the current risk, we need to know how we got here. Essentially, we are where we are because of how the authorities responded to the GFC.

In 2008, the immediate threat facing the financial system wasn’t the sheer impossibility of ever repaying the debt mountain created in previous years. Most debt doesn’t have to be repaid immediately, and can often be replaced or rolled-over.

Rather, the “clear and present danger” back then was an inability to keep up interest payments on that debt. Because the spending of borrowed money had given an artificial boost to apparent economic activity, there was widespread complacency about how much debt we could actually afford to service. When the crash unmasked the weakness of borrowers, it became glaringly apparent that the debt mountain simply couldn’t be serviced at a ‘normal’ rate of interest (with ‘normal’, for our purposes, meaning rates in the range 4-6%).

The obvious response was to circumvent this debt service problem by slashing rates. Cutting policy rates was a relatively straightforward, administrative exercise for central bankers. But prevailing rates aren’t determined by policy alone, because markets have a very big say in rate-setting. This, ultimately, was why QE (quantitative easing) was implemented. QE enabled central banks to drive down bond yields, by using gigantic buying power to push up the prices of bonds.

Beyond the mistaken assurance that QE wasn’t the same as “printing money” – so wouldn’t drive inflation up – little or no thought seems to have been devoted to the medium- or longer-term consequences of monetary adventurism.

In essence, ZIRP (zero interest rate policy) was a medicine employed to rescue a patient in immediate danger. Even when responding to a crisis, however, the wise physician is cognisant of two drug risks – side-effects, and addiction.

The financial physicians considered neither of these risks in their panic response to 2008. The result is that today we have addiction to cheap money, and we are suffering some economic side-effects that are very nasty indeed.

The inflation delusion

Even the assurance about inflation was misleading, because increasing the quantity of money without simultaneously increasing the supply of goods and services must create inflation. This is a mathematical certainty.

Rather, the only question is where the inflation is going to turn up.

As has been well explained elsewhere, handing new money to everyone would drive up general inflation. Giving all of it to little girls, on the other hand, would drive up the price of Barbie dolls. Since QE handed money to capital markets, its effect was to drive up the price of assets.

That much was predictable. Unfortunately, though, when policymakers think about inflation, they usually think only in terms of high street prices. When, for example, the Bank of England was given a degree of independence in 1997, its remit was framed wholly in CPI terms, as though the concept of asset inflation hadn’t occurred to anyone.

This is a dangerous blind-spot. The reality is that asset inflation is every bit as ‘real’ as high street inflation – and can be every bit as harmful.

Massive damage

In itself, though, inflation (asset or otherwise) is neither the only nor the worst consequence of extreme monetary recklessness. Taken overall, shifting the basis of the entire economy onto ultra-cheap money must be one of the most damaging policies ever adopted.

Indeed, it is harmful enough to make Soviet collectivism look almost rational.

The essence of cheap money is policy to transform the relationship between assets and incomes through the brute force of monetary manipulation.

Like communism before it, this manipulation seeks to over-rule market forces which, in a sane world, would be allowed to determine this relationship.

By manipulating interest rates, and thereby unavoidably distorting all returns on capital, this policy has all but destroyed rational investment.

Take pensions as an example. Historically, a saver needing $10,000 in twenty-five years’ time could achieve this by investing about $2,400 today. Now, though, he would need to invest around $6,500 to attain the same result.

In effect, manipulating rates of return has crippled the ability to save, raising the cost of pension provision by a factor of about 2.7x.

Therefore, if (say) saving an affordable 10% of income represented adequate provision in the past, the equivalent savings rate required now is 27%. This is completely unaffordable for the vast majority.  In effect, then – and for all but the very richest – policymakers have destroyed the ability to save for retirement.

Small wonder that, for eight countries alone, a recent study calculated pension shortfalls at $67 trillion, a number projected to rise to $428 trillion (at 2015 values) by 2050.

What this amounts to is cannibalizing the economy. This is a good way to think about what happens when we subsidise current consumption by destroying the ability to provide for the future.

Savings, of course, are a flip-side of investment, so the destruction of the ability to save simultaneously cripples the capability to invest efficiently as well. The transmission mechanism is the ultra-low rate of return that can now be earned on capital.

A further adverse effect of monetary adventurism has been to stop the necessary process of “creative destruction” in its tracks. In a healthy economy, it is vital that weak competitors go under, freeing up capital and market share for new, more dynamic entrants. Very often, the victims of this process are brought down by an inability to service their debts. So, by keeping these “zombies” afloat, cheap money makes it difficult for new companies to compete.

Obviously, we also have a problem with inflated asset values in classes such as stocks, bonds and property. These elevated values build in crash potential, and steer investors towards ever greater risk in pursuit of yield. Inflated property prices are damaging in many ways. They tend towards complacency about credit. They impair labour mobility, and discriminate against the young.

More broadly, the combination of inflated asset values and depressed incomes provides adverse incentives, favouring speculation over innovation. And this is where some of the world’s more incompetent governments have stepped in to make things even worse.

In any economic situation, there’s nothing that can’t be made worse if government really works at it. The problems created by “zombie” companies are worsened where government fails to enforce competition by breaking up market domination. Though the EU is quite proactive over promoting competition, the governments of America and Britain repeatedly demonstrate their frail grasp of market economics when they fail to do the same.

Worse still, the US and the UK [and AUSTRALIA…] actually increase the shift of incentives towards speculation and away from innovation. Having failed to tax the gains handed gratuitously to investors by QE, these countries follow policies designed to favour speculation. Capital gains are often taxed at rates less than income, and these gains are sheltered by allowances vastly larger than are available on income.

The United Kingdom has even backstopped property markets using cheap credit, apparently under the delusional belief that inflated house prices are somehow “good” for the economy.

How will it happen?

As we’ve seen, monetary recklessness – forced on central bankers by the GFC, but now extended for far too long – has weakened economic performance as well as intensifying risk. In some instances, fiscal policy has made a bad problem worse.

In short, the years since the crash have been characterised by some of the most idiotic policies ever contemplated.

All that remains to consider is how the crash happens. The prediction made here is that, this time around, it will be currencies, rather than banks, which will be first suffer the crisis-inducing loss of trust (though this crisis seems certain to engulf the banks as well, and pretty quickly).

The big question is whether the collapse of faith in currencies will begin in a localized way, or will happen systemically.

The former seems likelier. Although Japan has now monetized its debt to a dangerous scale (with the Bank of Japan now owning very nearly half of all Japanese government bonds), by far the most at-risk major currency is the British pound.

In an earlier article, we examined the case for a sterling crash, so this need not be revisited here. In short, it’s hard to find any reason at all for owning sterling, given the state of the economy. On top of this, there are at least two potential pitfalls.  One of these is “Brexit”, and the other is the very real possibility than an exasperated public might elect a far-left government.

Given a major common factor – the fatuity of the “Anglo-American economic model” – it is tempting to think that the dollar might be the next currency at risk. There are, pretty obviously, significant weaknesses in the American economy. But the dollar enjoys one crucial advantage over sterling, and that is the “petro-prop”. Because oil (and other commodities) are priced in dollars, anyone wanting to purchase them has to buy dollars first. This provides support for the dollar, despite America’s economic weaknesses (which include cheap money, and a failure to break up market-dominating players across a series of important sectors).

[ED. More and more countries, not least China, are now buying oil without US$]

Conclusion

Once the loss of trust in currencies gets under way, many different weaknesses are likely to be exposed.

The single most likely sequence starts with a sterling crash. By elevating the local value of debt denominated in foreign currencies, this could raise the spectre of default, which could in turn have devastating effects on faith in the balance sheets of other countries. Moreover, a collapse in Britain would, in itself, inflict grave damage on the world economy.

Of course, how the next crisis happens is unknowable, and is largely a secondary question. Right now, there are two points which need to be taken on board.

First, the sheer abnormality of current conditions makes a new financial crisis highly likely.

Second, rather than assume that banks will again be in the eye of the storm, we should be looking instead at the most vulnerable currencies.

Losing faith in banks, as happened in 2007-08, was bad enough.

But a loss of faith in money would be very, very much worse.