The major central banks have pursued a “zero interest rate policy” known as ZIRP, since the financial crisis of 2008-2009. More than $10.5 trillion of artificial credit were created. Has this unprecedented policy, never before seen in history, caused sustainable economic recoveries?
The evidence says: “No way.”
No recession, not even the Great Depression, has seen such anemic economic growth. Looking at it scientifically, instead of as an economist, we must ask, “Have central bank efforts to ‘stimulate’ actually done the opposite?” Has ZIRP actually contributed to global deflation?
Speaking at the International Finance Forum 2014 Conference in Beijing on November 1, 2014, the very influential Jaime Caruana, General Manager at the Bank for International Settlements (BIS), often called the “central bank for central bankers,” warned:
“…the build-up of financial imbalances risks a future financial crisis, an impaired financial sector and a debt overhang.”
The U.S. Federal Reserve has created an unprecedented $4 trillion out of thin air. The ECB in Europe has bought hundreds of billions of euros of government bonds in the market place. It is now apparently ready to create one trillion euros via new bond purchases.
Japan is an excellent example of the folly of central bank “stimulus.” In 2013 Japan surprised the markets with a huge $1.4 trillion stimulus and bond buying program. In proportion to GDP, that is twice the amount of the U.S. Federal Reserve’s last, huge quantitative easing effort. But Japan did something unintelligent: it raised the sales tax mid-year. In early 2014, I had predicted in the Wellington Letter that this planned tax hike would drive Japan’s economy back into recession.
After this summer’s sales tax hike in Japan, we wrote that Japan’s economy was coming to a screeching halt. Immediately thereafter, in the quarter ending June, Japan’s GDP plunged an amazing 7.1%. Such a plunge is usually only seen during depressions.
But economists didn’t worry, and just blamed it on the sales tax hike. We replied: it doesn’t matter what caused it, but it is happening. How can anyone ignore such a catastrophic decline?
On November 17, 2014 Japan released another shock: in the quarter ending September, GDP growth declined 1.6%. Two consecutive declining quarters qualify as a “recession.” That’s what they got for the biggest central bank stimulus in world history.
The Japanese government apparently had advance notice. On October 31, they announced another record shattering expansion of stimulus of about $800 billion. The reason: “inflation” is not rising as expected.
Additionally, the government and its pension fund will purchase ETFs in the market, not just in Japan’s own, but around the world. This is unprecedented. Governments everywhere usually follow the strategy: “if something doesn’t work, do more of it.”
Europe will now have a skirmish with deflation and recession. Deflation is appearing everywhere. Some of the major countries are on the borderline of recession. Even Germany saw negative economic growth last quarter. All the central bank’s (ECB) stimulus have done nothing except kept the zombie banks afloat.
What to do? On Nov. 17, the head of the ECB, Mario Draghi, announced that buying government bonds from around the euro zone is an option. He didn’t say that Germany must consent, although it is prohibited by German law for the country to participate in such action. Germany’s leadership recognizes the dangers of these programs.
China’s private sector economy is now going into recession in spite of the ‘official’ GDP growth of 7.3%, which is largely fiction. According to my work, China has been in a severe credit crunch since June 2013 when short term interest rates quadrupled overnight, from around 6% to 25%. Analysts ignored it and said it was “just a fluke.” Well, such flukes don’t happen in very large markets. It was a signal that the China credit crisis was accelerating and that the government was losing control.
China says that it will not bail out private companies. But it is ready to buy huge amounts of local government debt, railway bonds, and provide liquidity to the governmentally owned banks, in order to let the immense credit bubble deflate slowly without causing a deep recession. That seldom works, if ever.
The China debt bubble grew from $9 trillion to about $24 trillion in just a few years. The property credit bubble is the biggest in world history. The government just injected $110 billion into the banking system in one month, an enormous amount. (Remember, the U.S. TARP program to rescue the U.S. from depression in 2009 was a total of $700 billion over several years, for a larger economy than China.)
Total central bank credit creation globally over the past six years is in excess of $10.5 trillion. Predicting that eight years ago would have been declared “crazy.”
Common “wisdom” would say this is inflationary. Nobel Laureate Dr. Milton Friedman said that inflation is always a monetary phenomenon. Instead the world is facing severe deflationary pressures. Why? Because this “liquidity” is stuck in the banks. They are not lending it out.
My analysis suggests that ZIRP may be the culprit for deflation and another recession. ZIRP has only boosted the major stock markets of the world, primarily the U.S. Because all the central bank liquidity is not used for economic activity, it is used for speculation. It has provided speculators with very cheap money for speculating in stocks.
The largest companies, including Apple, have borrowed hundreds of billions of dollars at very low interest rates to buy back their stock. For Apple, the buyback is a huge $130 billion. Is this productive investing? For the top executives it is “productive” as it makes the stock, and thus their stock options, appreciate in value. And that is the reason for the “bull markets.” Every other traditional group of buyers, such as mutual funds, private and governmental pension plans, have been net sellers the past five years.
IBM is another company doing large buybacks. Since 2007, the company has spent $60.4 billion buying its own stock. Annual capital spending and R&D have been about between $10 billion and $11 billion annually respectively, with virtually no growth. For IBM, “engineering” apparently means financial engineering.
Stock buybacks are apparently not well understood, even by investment professionals. Recently I discussed Apple’s buyback program on CNBC. The bull on the program said it was great that Apple was “returning money to shareholders via buybacks.” I replied, “Is that why you buy a stock of a company, in the hope of the company buying the stock back from you?” Often I don’t understand Wall Street thinking.
Contrary to Wall Street economists, the danger of these greatest central bank monetary experiments in history will eventually come to a very painful end. At first, every approaching crisis will be countered by the central banks with additional stimulus. The subsequent rallies will be smaller and smaller until they have no effect at all. We already see progression in Europe, China, and Japan. That just creates greater bubbles.
Throughout history when individual countries pursued such policies, it always led to a collapse. But now we have all the major countries of the world following the same policies simultaneously. It’s logical that this could cause a global collapse with no island of safety. An unstoppable crash is unlikely. However, severe convulsions in the markets are inevitable. Now that everyone is very bullish again, it could happen in the not-to-distant future. Be alert!
This is a great scenario for stock market investors who are agile and are able to protect themselves, or sell short, during the periodic sharp market plunges. Active investing becomes lucrative. If you know what to do, you can profit immensely along with the “movers and shakers” of the financial world.
Going into 2015, investors must be aware of the danger of a severe shock to the financial markets. This is no time to get your financial advice from the daily newspaper or direct mail pieces. “Free” advice is usually worth much less than you pay for it.
If you don’t know, you will suffer along with all the retired people who see their retirement income decline to 1%-2% per year, hardly enough to pay the rent. In my Wellington Letter, we discuss these important topics and forecast the important events on a continuing basis.
Hope for the best, but be prepared for the worst. And make sure you have the best and most knowledgeable advice available. This is not an environment for getting the cheapest advice. It’s like brain surgery: when you need it, you have to get the best surgeon with the most experience.
Wishing you successful investing,
Bert Dohmen, Founder
Dohmen Capital Research, Inc.