Central Banks: The great experiment has failed

Central banks have several official functions. The first is to regulate the smooth and orderly operation of private banks or public banks within a particular country or region (the ECB is responsible for many countries in Europe). The other function is setting interest rates (the cost of borrowing money) so that there’s adequate economic balance between full employment and a select inflation rate. The idea is that if the cost of money is cheap enough, private banks will lend to the general population and businesses. The ultimate goal is that the money can be used to expand enterprise, hire people and develop a stronger economy.

Since the financial crisis (2008), the US central bank Fed has produced nearly $4.5 trillion (in 2008-2018) in funds to buy bonds (assets) from the major private banks. The reality is central banks have provided money as cheaply as possible to banks in order to keep the private banking system operating. The Fed’s playbook was then deployed across the world by other central banks.

Since the 2008 crisis, the G7 central banks collectively fabricated $21 trillion worth of new money.They took the liberty to buy government bonds, corporate bonds, mortgage bonds and, in the case of Japan, ETFs (exchange-traded funds). This meant that an external massive supply of money was injected into the world’s markets. These actions pushed markets higher and the bond markets were inflated with this excess money, causing a new round of debt bubbles.

Companies could borrow money and buy their own stocks on the cheap, increasing the size of corporate debt and the level of the stock market to record highs. Because money was so cheap and interest rates so low, no other investment opportunities could offer the same high returns, so speculators piled into the stock markets, further elevating their levels. Much of that debt was created because the central banks offered up money at such cheap levels to borrow. Corporate debt and the markets have been built to such great highs that the potential for a drastic fall would be at an unprecedented level. To further complicate the matter, record buybacks occurring in the markets but such landmark moves are not connected to organic growth and are detached from the foundation of any economy.

Perhaps most alarming is that we have not seen any real steps to reform the global financial system. Despite some cosmetic regulations to curtail certain risky behaviors, there is still no division between depositors’ funds and those used by banks for speculation. The big banks continue to make massive trading bets and corporations are still focused on buying back stock for short-term shareholder gains rather than reinvestment in their businesses.

Global GDP has been still propped up by a massive amount of debt. While the governments and economists continued to publish strong GDP figures (before COVID-19 outbreak in March 2020), they seem to overlook how much debt it took to produce that growth.  According to data from the IMF and the Institute of International Finance, global debt increased four times more than the GDP growth during the first quarter of 2018.  The IMF forecasts Global GDP to reach $84.8 trillion in 2018 and theInstitute of International Finance reported total world debt increased by $8 trillion in the first quarter of 2018.

So, the world is now adding an astonishing six dollars of debt for each dollar of GDP growth.

When the global debt is increasing, so must the interest expense to service this ever-increasing amount of debt.  When the debt service starts to compete with global GDP growth, in the time of increasing interest rate, then we have a serious problem. 

The world’s greatest bubbles are bigger than ever. In just past few years, global asset values have risen to the biggest bubbles in history. 

According to a recent update by Savills (a global real estate services provider listed on the London Stock Exchange), the values of global real estate, securitized debt and equities, as they have jumped over $100 trillion in just two years, are now in extreme bubble territory. 

Credit Suisse recently published the report “Global Wealth Report 2018”.

According to the study, total global wealth increased to a new record of $280 trillion in 2017. When comparing those figures with the previous debt figures (IMF, WB, IIF), the big picture is quite dramatic. When looking at the increase in total world debt and total global wealth over the past 20 years, we can see a troubling sign.

Since 1997, total global debt increased from $50 trillion to $233 trillion compared to the rise in global wealth from $120 trillion to $280 trillion.  There are two disturbing trends shown in the chart above:

  1.  Global Debt has increased 366% vs. 133% for Global Wealth since 1997
  2.  Net Wealth was $70 trillion in 1997 versus $47 trillion in 2017

If we compared the percentage increase in global debt versus global wealth, global debt is rising at nearly three times the rate of global wealth.  Furthermore, doing simple arithmetic by subtracting DEBTS from ASSETS, global net worth fell from $70 trillion in 1997 to $47 trillion in 2017.

By putting the numbers together, we can clearly see that the world is going broke by adding debt.