I Bring Bad Tidings

Guest Post by The Zman

Recently, I was involved, in a limited basis, with a bankruptcy. The company that went belly up had over a million dollars in debts and no assets. Most of their debt was in the form of accounts receivable, but they had some loans and leases as well. Up until the point they filed for bankruptcy protection, they had paid all of their bills on time. In fact, they paid most vendors in ten days, something that is just about unheard of these days. This prompt payment is what led their vendors to be so generous with them.

This story reminded me of something that happened years ago. There was a house party at a mansion (are there mansion parties?) and many party goers were out on a balcony of some sort that extended over the pool area. The balcony was large enough to hold dozens of people, but it started to give way due to the mass of people. Panic set in and that made things worse as the frightened party goers scrambled to get off the balcony. The whole thing collapsed and took a bunch of people down in the process.

The connection here is that it is human nature to observe the actions of others, trust those actions and to infer things from them. The vendors extended terms to that business saw that they paid in ten days and that others were more than happy to extend credit, so they did the same. The party goers saw everyone else out on the balcony and just assumed it must be safe. They never stopped to think that maybe it was not built to hold a hundred people. In both cases, when reality came rushing in, there was a rush to the exit.

That’s something I think about when I read stories like this regarding the global economy. The entirety of the world economy is built on one thing. That is the rock solid belief that the US government will never miss a debt payment and never devalue the dollar to arrest its debt. The entire global economy is built on the asset value of US Treasuries. If there ever comes a time when people begin to doubt the security of that debt, the panic will plunge the world into a new dark age or possible something worse.

The people in charge of the Federal Reserve understand this. The people running the ECB know this. The PBOC knows this. The masters of the universe all agree on one thing and that is they have to protect the foundation stone of the world economy. Guarding the underlying stability of the financial system is their overriding concern. That means they are willing to risk recession and maybe worse in order to protect the asset system. It’s not unreasonable from their perspective, but it does reveal the bigger problem.

That bigger problem is we have reached the logical end point of the credit economy. If the US economy does lurch into recession, the world economy will follow. The central banks will not have many options as they have used all of their big tools to prop up the asset base over the last decade. The Fed can lower rates a bit and maybe restart their Quantitative Easing program, but they will have little or no success in blunting a recession. The world will just have to wait it out and hope for the best.

That is not how the world ever works. A 2017 recession will cause the new US president to propose “solutions” and new governments in Europe will demand relief from Brussels. Bad economics always leads to worse politics and the politics of the West are already fairly rotten. The rise of nationalist and populist parties in Europe will only complicate an already fragile set of arrangements. Imagine if something like a Syriza were to take over the Italian government just as the world is headed to recession. Fun times.

The fact is, there’s a limit to how much the world can borrow from the future. We are probably near that limit. With recession looming, the ability of central bankers to blunt it with credit issuance is limited. That means it becomes a political problem. The record of politicians coming up with useful reforms in times of crisis is not good. What’s needed is a sustained and organized retreat from a money system that has outlived its usefulness, but that is probably impossible. Instead it means a disorganized and haphazard retreat.

As Evans-Pritchard concludes in his story, the possible outcomes are mostly grim with some of them very grim. If the central bankers get it wrong and plunge the economy into a deep recession, the politicians will most likely respond with massive spending of money that does not exist. That could unleash price inflation and a collapse of asset values. It’s not guaranteed, but the fact that it is one possible outcome is grim news in itself. The future is grim and things will mostly likely be worse than we expect.