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Consequences of faulty central bank policies

Dr. Tillmann C. Lauk (LL.M.)

ECAEF Workshop, Bratislava

08 September 2016

Disclaimer

The material contained in this presentation is incomplete without the oral comments andexplanations given during the workshops. This material should not be read in isolation.

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About the speaker

Dr. Tillmann Lauk (LL.M.) is author of the book “The Triple Crisis of Western Capitalism –Democracy, Banking, and Currency” (Palgrave/Macmillan; London/New York; (November 2014)).He was born in Stuttgart (Germany), and studied law and protestant theology. As a FulbrightScholar he gained a postgraduate degree at Columbia Law and Business School, New York. Afterworking for six years with the Boston Consulting Group, he held various executive positions,including at the Executive Board of Deutsche Bank AG and as a founder and CEO of a venturecapital fund. He lives in Barcelona, from where he pursues various academic and entrepreneurialinterests. If reference is made to the speaker´s book, it will appear in the footnotes as “The TripleCrisis, p.”

Since the GFC1 of 2008 all central banks of the Triade are pursuing the same monetary policies

3[1] GFC = Global Financial Crisis; [2] QE = Quantitative Easing; [3] ZIRP = Zero Interest Rate Policy; [4] NIRP = Negative Interest Rate Policy

“Conventional monetary policy easing works by lowering market expectations forthe future path of short-term interest rates, which, in turn, reduces the current levelof longer-term interest rates and contributes to an easing in broader financialconditions. These changes, by reducing borrowing costs and raising asset prices,

bolster household and business spending and thus increase economic activity.”

Chairman Ben S. Bernanke, The Eoconomic Outlook and Macroeconomic Policy, 03 February 2011

All central banks of the advanced-/over-indebted economies stick to this recipe

The main tools are QE2, ZIRP3 and NIRP4 and possibly in the future „helicopter money“ and a ban of cash

All tools have in common that they are highly repressive, malicious for the economy (mal investments), they stealthy expropriate savers, and massively hurt retirees

What the tool-kit of central banks is targeting at

• Quantitative Easing means buying assets from the commercial banking system which in return gives cash tothe private banking sector. The money required for those purchases is simply „printed out of thin air“

• 1st Rationale: increase credit to the economy in order to stimulate aggregate demand = what is supposed tospur productive investment and employment

• 2nd rationale: create a wealth effect through raising asset prices = equities and other (financial) assets

• 3rd rationale: through this increase of the money supply try to create controlled inflation and to devaluecurrencies in the hope to stimulate exports

• 4th rationale: ZIRP or even NIRP aim at (a) bringing down the debt service obligations of the ever increasingsovereign debt and (b) forcing savers to spend

4Now, let´s check whether data support that statement

Like its brethren FED, BOE, and BOJ, the ECB is also embarking upon Quantitative Easing (QE)

• After a halt in 2015 ECB now starts again an aggressive asset purchase spree

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All major central banks adopt the same monetarypolicy – inject liquidity, expand money supply

The permanent injection of liquidity by global central banks drove the rally in stock markets

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”We frontloaded a tremendous market rally to create a wealth effect ... The Federal Reserve is a giant weapon that has noammunition left….. These markets are heavily priced. They are trading at 19 and a half time earnings without having top linegrowth you would like to have. We are late in the cycle. These are richly priced. They are not cheap. .... I could see a significantdownside.”

The former President of the Dallas Fed, Richard Fisher, said in a CNBC interview1

[1] Richard Fisher, CNBC interview; (06 January 2016)

Since the GFC of 2008 only the top 1% experienced the wealth effect – the bottom 99% lost wealth- hence the wealth effect didn´t work for the middle class in advanced economies

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SOURCE: World Economic Forum 2016; Oxfam

The median household income fell in the U.S. back to the level in the 90ies by any measure –consumer spending stands for ca. 70% of the U.S. GDP. Can it really grow GDP?

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The monetary easing policy of the ECB also drove up real estate prices in the EU

• This policy makes housing for the middle classmore expensive and renting as well

• At the same time people cannot save due to ultra-low interest rate policy

• This puts the population between a rock and ahard place

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Wealth effect completed?

YES – however for the top 10% only

Since 2008 wealth inequality increased andmedian household income shrank

The QE driven liquidity injections into the banking system did not spur productiveinvestment – instead accounting chimeras

28% of operating cashflow were invested inbuybacks

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Instead of channeling the newly created money into productive investments many S&P 500 corporationsembarked upon financial engineering – i.e., share buybacks and M&A in order to lift earnings - realinvestment fell from 3.7% of GDP in 2007 to 2% in 2014

ZIRP and NIRP are distorting market-based price discovery – in particular risk gets underpriced

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Interest rates for italiansovereign bonds are atridiculous low levels –hiding massivedevaluation risks forinvestors – like pensionfunds

Italy´s debt-to-GDP ratiois 130% and growthperspectives are negative

Italy will never be able torepay its debt

NIRP is severly punishing savers and investors

The rationale for the introduction of NIRP is to forcesavers into spending

NIRP is a perfect example for „financial repression“

Meanwhile, the amount of global debt carryingnegative yields is around USD 13 trillion

Moreover, instead of spending people start saving1

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[1] John Doukas, Unintended consequences of the ECB´s QE programme could undermine Europe´s recovery; London School of Economics Blog; (22 June 2015). See also Bloomberg.com, Gross tells FED to “Get Off Zero Now!” as Economies Run on Empty; (23 September 2015)

NIRP will hurt retirees in advanced economies worst – mass pauperization of pensioners foreseeable

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At the end of 2013, the median 401(k) plan held by US households near retirement had abalance of $104,000, according to the National Institute on Retirement Security. Following thetypical actuarial recommendation of withdrawing no more than 4 per cent a year, this wouldprovide an annual income of about $4,0001.

[1] Pensions: Low yields, high stress, ft.com, 22 Aug 16

Why ZIRP and NIRP are essential for sovereign survival – example USA and Italy

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If interest rates were ever to reachhistorical levels the U.S. governmentwould simply collapse – the same will holdtrue for Italy

The announcement in March 2016 to start purchases of corporate bonds amounts to a monetarycrime

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Why? It punishes savers and rewards speculators via ECB´s de-facto front-running. Speculators know thatbond prices will increase due to reckless buying of the ECB – in particular with the new CSPP1 - they onlyneed to buy what the ECB did not buy in the first run

[1] CSPP = Corporate Sector Purchase Programme; [2] For detailed analysis see: Zerohedge.com, So what Did The ECB Buy? „In Short, Almost Everything“; 19 July 2016

So far the ECB bought 440 corporate bonds from 158 different corporations2

CSPP in reality is QE for the(corporate) world – ECB boughtbonds across the westernhemisphere like Switzerland, UK,und U.S.

ECB also bought poorly ratedbonds

The resulting market- and pricedistortion is incomprehensible –mal investments to follow……..

CSSP is a textbook example of massive market manipulation through central planners

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The price finding mechanisms of free marketsbecame eliminated – mis-allocation of capital1foreseeable – the curse of central planning and itseffects on a globally interconnected economy

Example: China´s steel industry2

“In the late 1990s, China had the capacity to manufacture100 million tons of steel. That figure today is 1.1 billiontons — almost twice the amount of annual demand forsteel in China.The China steelmaking boom also sent the price for ironore up to nearly $200 a ton in 2011, from around $30 in2008. Like all commodity prices, it has fallen sharply, to justunder $100, a correction that creates problems for big ironore-producing countries like Australia, which made hugeinvestments to keep supplying these raw materials toChina.”

[1] The Triple Crisis, pp. 58, (Austrian School of Economics); [2]Signs, Long Unheeded, Now Point to Risks in U.S. Economy, nytimes.com, 25 August 2015

Is the BoJ the role model for the ECB in becoming the largest shareholder in the stock markets – just to createan even stronger „wealth effect“?

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By 2017, the BoJ will rank No. 1 in about a quarter of Nikkeis index’s members, including Olympus Corp., theworld’s biggest maker of endoscopes; Fanuc Corp., the largest producer of industrial robots; and Advantest Corp.,one of the top manufacturers of semiconductor-testing devices.

Meanwhile SNB holds more publicly traded shares in Facebook than Marc Zuckerberg

Why do all central banks of the developed/over-indebted economies pursueinflation targets?

• Because „controlled“ inflation is a hidden tool to enhance the debt-service capability of governments bydepriving citizens of their wealth1

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[1] The Triple Crisis, pp. 197; [2] In the IMF Working Paper (WP/13/266 from December 2013) the authors (Carmen Reinhart and Kenneth Rogoff) explicitly recommend the use of inflation in combination with financial repression to bring down sovereign debt, ibid p. 49

Scenario-1Inflation: 0%Real interest rate: 2%Interst income on savings: 2%Tax rate: 40%Net interest income: 1.2%Government income: 0.8%

Scenario-2Inflation: 2%Real interest rate: 2%Interest income on savings: 4%Tax rate: 40%Net interest income: 2.4%Government income: 1.6%

Scenario-3Inflation: 4%Real interest rate: 2%Interest income on savings: 6%Tax rate: 40%Net interest income: - 0.4% (3.6 – 4)Government income: 2.4%

Moreover, if nominal GDP growth is above the nominal interest rate the debt-to-GDP-ratio will becomemore favorable and by this reduce indebtedness2

Did the ECB meet its targets so far? – Stimulation of economic growth and inflation of 2%

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Obviously not – as the charts below indicate. This is true for all the other countries in which the centralbanks adopt the same monetary policy. The Keynesian-/neo-classic synthesis madness of believing to beable to centrally plan a complex system1 like the economy only leads to financial repression and hardshipfor the citizens

[1] As to complexity theory see: The Triple Crisis, pp. 56, fn 50/72/213

Inspite of ECB´s activism economic growth prospects for the eurozone might get even worse

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In January 2016 the IMF published a workingpaper outlining a downside scenario for theeurozone1

Economy Real GDP Real Investment

Germany - 1,6 - 2,0

France - 1,7 - 6,6

Italy - 1,9 - 6,5

Spain - 2,2 - 8,7

Greece - 3,5 - 16,5

Ireland - 3,6 - 17,5

Portugal - 2,3 - 7,7

Euro area - 1,9 - 7,1

[1] IMF Working Paper WP/16/9, Risks of Stagnation in the Euro Area; (January 2016). [2] Labor Minister Says France Is "Totally Bankrupt" – by: Zero Hedge, 28 January 2013; also: IMF-Working Paper, How Do Fiscal and Labor Policies in France Affect Inequality? (February 2016)

Problem is that „macroprudential“ monetarypolicy cannot substitute the need for structuralreforms – in particular excessive labor laws likein France or Italy2

The role of debt in an economy escapes the intellectual framework of central planners

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Mainstream economic models do not adequately consider the role of debt. Whereas non-mainstreameconomists do so - e.g., Post-Keynesians1 and „Austrians“They distinguish between the productive- and the financial sector labelled as FIRE sector (Finance, Insurance,Real Estate)

Productive sector = industry which produces goods and services not dependent on rising asset pricesFIRE sector = income depends on interest on debt and rising asset prices

From 1980 to 2008 the FIRE sector crowded out the productive sector by providing greater returnson capital invested in asset price inflation and interest on debt than investment in productiveenterprise. In the GFC the FIRE sector collapsed. This collapse spilled over into the productive sectorby reducing consumer and business access to all forms of credit.

A collapsing FIRE Economy is accompanied by debt deflation, falling demand, debt defaults, businessfailures, and rising unemployment. If (bad) debt is not written off – deflation continues2

[1] See: http://www.fireeconomy.com/ and „The Triple Crisis“, pp. 60; [2] Fisher, Irving, (2010), The Debt-Deflation Theory of Great Depression, 1st edn, (Thailand, ThaiSunset Publication, Reprint of 1933 edn); see also: Michael Hudson; KILLING THE HOST – How Financial Parasites and Debt Destroy the Global Economy; (2015 – ISLET)

What central planners didn´t achieve and what they did achieve

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What central planners did not achieve What central planners did achieve

Did not meet their inflation targets asdefined in official CPIs

Did not achieve higher employment1

Did not achieve sound economic growth norhigher „aggregate demand“

Did not achieve reduction of debt

A massive asset price inflation particularly in stock,bonds and real estate – not reflected in CPIs

Stagnation/reduction of median household income

A massacre among savers and retirees (pensionfunds, insurance groups)

Massive build-up of public and private debt2

[1] Post GFC job growth only took place in the part-time and low-wage category; „breadwinning jobs“ were not recovered; see: „The Triple Crisis“, pp. 59; [2] Ron Paul, Our central bankers areintellectually bankrupt, FT.com; (02 May 2012); (2) According to report of the McKinsey Global Institute published in February 2015 global debt is now at USD 200 trillion leading to a global debt-to-GDP ratio of 286%. – it says:7 years after the global financial crisis, global debt and leverage have continued to grow. From 2007 through the second quarter of 2014, global debt grew by $57trillion, raising the ratio of global debt to GDP by 17 percentage points is enough to raise fresh concerns. Governments in advanced economies have borrowed heavily to fund bailouts in the crisisand offset falling demand in the recession, while corporate and household debt in a range of countries continues to grow rapidly.

“The financial crisis has fully exposed the intellectual bankruptcy of the world’s central bankers. Why? Centralbankers neglect the fact that interest rates are prices. Manipulating those prices through credit expansion orcontraction has real and deleterious effects on the economy. Yet while socialism and centralised economicplanning have largely been rejected by free-market economists, the myth persists that central banks are anecessary component of market economies………”2