Submitted by David Stockman – The Contra Corner Blog
The financial system of the world has been turned into a doomsday machine by central bankers stranded in an intellectual puzzle palace. That is, they are marching financial markets straight into another giant bubble implosion owing to their embrace of a fundamental error about why there is an apparent lack of consumer inflation in the official indices.
For example, the chief economist of the IMF, Maurice Obstfeld, recently trotted out the chart below to prove that “lowflation” is a deadly threat everywhere on the planet to growth, jobs, living standards, public finances, and even capitalist viability.
The ill of lowflation can only be remedied, he averred, by resort to “out of the box” central bank expedients designed to compensate for the purported drastic shortfall of that Keynesian ether called “aggregate demand”.
What he had in mind, of course, was negative interest rates and further massive monetization of the public debt and other existing assets in the name of QE.
Mr. Obstfeld is talking central banker jabberwocky. The above graph is actually welcome evidence that wage workers and other middle class households are finally getting some respite from the relentless upward creep of consumer prices.
Moreover, the above graph represents no problem whatsoever because better retention of the purchasing power of wages and salaries is surely not something that needs fixing. And most especially not by the very same central bankers whose misguided policies gave rise to the deflationary tides now gathering in the world economy.
In a nearby post today, Pater Tenebrarum called out exactly what these “moar inflation” seeking central bankers are really up to:
What are the basic requirements for becoming the chief economist of the IMF? Judging from what we have seen so far, the person concerned has to be a died-in-the-wool statist and fully agree with the (neo-) Keynesian faith, i.e., he or she has to support more of the same hoary inflationism that has never worked in recorded history anywhere. In other words, to qualify for that fat 100% tax-free salary (ironically paid for by assorted tax serfs), one has to be in favor of central economic planning and support policies fully in line with today’s economically illiterate orthodoxy. Meet Maurice Obstfeld, who has just taken the mantle.
New IMF chief economist Maurice Obstfeld (left) and fellow monetary crankHaruhiko “Peter Pan” Kuroda, governor of the BoJ
So trapped in their illiterate orthodoxy, Obstfeld, Kuroda, Yellen, Draghi and the rest the central bankers cartel resort to desperate monetary expedients that would have been considered crackpot economics even 15 years ago. The idea of ZIRP for 82 months running would have been considered borderline lunacy; the notion that the collective central bank balance sheets of the world could explode by 10X in two decades would have been viewed as incendiary radicalism.
But it is exactly these crackpot doctrines which have now become embedded in a relentlessly tedious central banker groupthink. Indeed, the core notion of “lowflation” and deficient “aggregate demand” is so superficial, contradictory and refutable that it amounts to little more than jabberwocky.
The fact is, the massive growth of central bank balance sheets since 1994 is the driving force that fueled, shaped and deformed today’s global economy and financial system. The chart below is utterly new under the sun and thereby nullifies the relevance of pre-1995 history and contradicts all of its rules and patterns:
When the central banks created $19 trillion of new balance sheet out of thin air they fueled a worldwide credit bubble of epic proportions. After two decades of maniacal central bank money printing, the world’s credit outstanding has grown from $40 trillion to $225 trillion or nearly 4X more than the interim expansion of global GDP.
And even that latter figure is exaggerated because it includes massive amounts of malinvestment and economic waste that will eventually be written off and abandoned; it does not comprise a permanent component of the world’s productive economy.
This massive expansion of cheap debt, in turn, fueled a runaway capital investment boom that has left the global economy drowning in excess capacity and malinvestment. This occurred in the form of a central bank enabled doubly whammy over the last two decades.
First, excess DM world household demand lead to an investment boom in China and its EM supply base prior to the 2008 “peak debt” crisis; and then the post-crisis infrastructure and investment binge staged by the red suzerains of Beijing fueled a second wave of capital spending for energy, metals, processing plants, shipping, warehousing, manufacturing and consumer product distribution that dwarfed all prior history.
As shown below, the publicly listed companies of the world actually increased CapEx by 5X or upwards of $2 trillion annually during the run-up to peak capital spending in 2012-2013:
The official inflation indices, therefore, are tepid because prices of commodities and goods are being crushed by excess supply. That’s why oil prices have plunged into the $40s and why iron ore is heading into the $30s (per ton) and copper back toward one dollar (per pound).
Moreover, the excess capacity is by no means limited to the mining sector and oil patch. Its rippling downstream at a ferocious pace. This week, for instance, we posted a piece on Alcoa’s intention to shutdown most of its US aluminum smelter capacity and the likelihood that in a few years the entire US industry will disappear.
Needless to say, that’s not owing to a labor arbitrage because today’s high tech, capital intensive power-guzzling aluminum smelters are not about underpaid peasant girls living a dozen to a dorm room; they are about return on capital, which has been driven to nearly zero by the China’s insane rates of cheap credit fueled investment over the past two decades.
The same is true for steel and all its downstream customers. In 1995 China had 70 million tons of steel capacity and no modern auto plants. In the interim, its steel production capacity grew by 16X to 1.1 billion tons and auto industry capacity to 26 million units or well more than either North America or Europe. The excess supply from these malinvestments will be deflating world prices for years to come.
And the same is true of containerships, bulk carriers, refineries, chemical plants, solar power, heavy machinery and much more.
The collateral effect will be collapsing profits, asset write-offs and a long spell of weak capital spending. Indeed, the developing depression in commodities and capital spending is what is driving the global deflationary cycle, and the collapse of profits and incomes in the impacted sectors.
Stated differently, the credit fueled commodity and CapEx boom of 1995-2014 did not generate a miracle of global growth and prosperity as the Wall Street Keynesians would have you believe; it simply stole demand from the future and wasted massive amounts of real labor, capital and energy resources in the process.
Accordingly, the world does not suffer from a lack of “aggregate demand”. Sustainable demand everywhere and always is derived from production and income, and the latter are now falling due to the wasteful capacity excesses overhanging the global economy.
And there is no short-cut way out via credit based spending. That’s because the world is now saturated with “peak debt” in the household and business sector, as well as the official institutions of the state. More central bank enabled credit will only fuel speculation in financial assets.
By the same token, the “lowflation” story is just self-evident drivel. On a worldwide basis, the price of commodities are falling due to excess supply. Likewise, prices of goods are being flattened by cheaper raw materials and the excess supply of labor that was drafted into the world’s tradeable goods economy from the rice paddies of Asia during the credit and CapEx boom of the last two decades.
By contrast, domestic services prices have continued to inflate at a 2.4% annual rate since commodity and goods prices began to peak in 2011. In fact, the roll-over of the green line (all commodities) and the red line (finished goods) is the cause of “lowflation” in the aggregate consumer price index. Only the central banker PhDs lost in a self-serving groupthink of jabberwocky can’t see the implications of the graph below.
In a word, the graph says to the central bankers: You are out of business!
The developing deflationary cycle stunting the world economy has arisen from the monumental harm that central bankers have already done, not from lack of sufficient vigor and boldness in attempting to contravene its consequences.