These are monumental days for a world torn apart by geopolitical conflict, ecological determinism, religious fanaticism and economic fragility. But if you ever thought that the world’s central bankers had a firm grip on understanding the various contradictions within global capitalism, you’d better think again. And if you ever thought that a robust and far-reaching nuclear deal with Iran would be possible, within a short week we should have a direct answer. Because by July 8th, either Washington or Tehran is going to blink. And I’m betting all the blinking is going to be done by an Obama administration which is hell-bent on a sweetheart deal for the Ayatollah.
In the meantime I’m watching the markets, as once again that global sinking feeling has started to set in. The world is awash with a massive debt hangover, and for the last seven years the central bankers have given us only one policy prescription — keep on drinking. It’s been like a giant brunch watered down with a sea of additional Bloody Marys. All this new drinking has been done in hopes of curing the original hangover. But as every drinker knows, at some point or other, the realization of more trouble becomes fixed and crystal clear: all the additional drinking is just not working. Is this the message of the collapse of the Greek economy? Is Greece just another black swan (an unexpected event) in a far more extensive global debt problem? I think so.
In order to cure the various crises of capitalism — major downturns or events potentially leading to major downturns — the world’s central bankers have continually dropped interest rates. They have done this in order to spur economic activity and provide additional liquidity to an over-stretched banking system. But such a monetary strategy can only work within a bandwidth of logical debt expansion. Once you go beyond a certain limit, the debt dominoes begin to have a momentum of their own. This new momentum begins to take place outside the magnetic strength or gravitational pull of monetary policy. Sooner or later the Keynesian gears become stripped, and the machine goes hay-wire, beyond the control of its operators.
The first major downturn of our modern red-ink era happened in 1987. Because of the brand new expansion of truly global markets (the beginning of the rise of China) the US dollar became over-valued, and US exports started to dwindle. But because of a past inflationary bias and a strong dollar, foreign money flooded into the US bond market. This lowered US interest rates as bond prices rose. The US Federal Reserve misread the situation of the dollar and raised interest rates as a cautionary step against future inflation. But the ensuing flood of foreign money into the US current account only made the dollar stronger and US exports more expensive. The contradiction then was between a strong dollar or US export-centered growth. Something had to give, and it did. The prospect of slow growth due to high interest rates and a strong dollar collapsed the US stock market.
October 1987 was a replay of the events of the market fifty-eight years earlier, in the fall of 1929. America hadn’t seen anything like it in decades, a stock market crash. The immediate answer was an infusion of cheap money into the system by a dramatic fall in interest rates. It worked. Within months the Wall St. markets had righted themselves. And as crisis followed upon crisis — Savings and Loan banks late 1980s and 1990s, Mexico 1992, Asia 1997, LTCM 1998, Dot-Com Bubble 2000, Sub-Prime Housing Bubble 2007, and the major US Investment Banks 2008 — monetary policy and record-low interest rates became the Keynesian policy of choice. And it worked; from crisis to crisis throwing cheap money at a mountain of debt (new debt upon old) has kept the global capitalist system from collapse for nearly thirty years.
But as the Jewish Bible warns, charging interest on money is a sin, and all debt should have a shelf life of only seven years. Somebody should explain the dangers of debt to the central bankers and the politicians who run the global economy. Because the amount of global debt now within the system at large is about to approach 200 trillion dollars! That works out to roughly 300 percent of global GDP. Talk about a hangover! Are these figures sustainable? We should find out soon. The current strategy has kept US interest rates so low, for so long, that finance itself has become the engine of growth of global capital. It is now much more profitable to borrow, in order to buy other peoples’ debts, than it is to produce in order to provide goods for exchange. The stock market has become a prime example. Companies are borrowing money at record levels, not in order to buy machinery for production, but in order to buy back their own stock. This drives up the price of their stock but does little for the economy as a whole.
This rigging of the financial system would not be possible without a firm understanding that central bankers cannot (and therefore will not) raise interest rates without tipping the entire mountain of debt upon their own heads. In other words, the entire human race is faced with being caught in the middle of a planetary interest-rate trap. What is the nature of the trap? The Bank of International Settlements has been warning about it for years. This institution based in Europe is supposed to be the central bank for all the world’s central banks. Each year they publish a major paper on the shape of the world economy and its many dangers. At the height of those dangers is low interest rates and the colossal accumulation of debt. The BIS has been warning that low interest rates can only lead to destabilization of the system. This could be through government debt, private debt, or a combination of both. The nature of this destabilization is the continuous creation of bubbles (the present US stock and bond markets) leading to their crash and causing a depression. Lowering interest rates in the face of such a problem only compounds the problem by kicking the can down the road. But raising interest rates is no answer either. That will certainly lead to the bursting of bubbles and a deflationary crash.
The BIS is not the only group of economists criticizing the central bankers; Marxists economists and the Austrian School (return to the gold standard) have criticized them as well. But if massive accumulation of debt (low interest rates) is not the answer to capitalism’s inherent inclination toward “boom and bust” economics, what is the answer? To tell you the truth, I don’t think there is an answer. Certainly the Jewish Bible was not meant to be an apology for a globalized world economy run by central bankers and massive finance. On the contrary, the essence of Torah economics is agrarian and biblical. The making of money by the use of money (finance) is strictly prohibited. Economics, according to Jewish law, has a distinct balance of nature about it. Growth means crops, not profits. So as the world waits to see how the Iran nuclear deal turns out, global politicians once again are faced with the never ending prospect of the growing debt over-hang. If all goes bad, at least the price and use of oil will definitely be falling. That will be good news for the global climate, but bad news for Iran and the world’s oil producers.