The Common Thread of the Destruction of Money

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Since the early 1990's we have been bombarded with the message that the world is a smaller place. Technology connected Gen X-ers like no generation had ever seen before, so those billions and trillions of new pathways for information flow made it appear, at least in some virtual manner, that borders and national boundaries were anachronistic. That technology of information also extended into the technology of finance and trade. The US economy was no longer viewed as a closed system (it never really was), but as simply a member of the global economy.

If we accept that idea of a global economy, then the worldwide slowdown should be as unsurprising as it is undeniable. The construction or framework of the global economic system is as an accumulation of regional subsets. Arranged in that manner, desperate problems in one region would be expected to have far reaching implications. Of course, some of the impacts are relatively straightforward and conform to traditional notions of trade and economics: regional proximity still counts for something. So we would expect that as Spain and Greece plumb further and further into the depths of currency hell that their closest neighbors would feel the collateral (pun intended) blowback. Striking and persistent weakness in Germany and Holland, for instance, is almost a given.

On the other hand, China is now experiencing growth rates on par with some of the worst days of 2009. In terms of physical proximity, China has little to fear from PIIGS. But the reach of global trade means that the winds of Southern Europe blow heavily in Beijing. Even the United States, the prime candidate for "decoupling" from the global chain, is no longer believed to be on the upward trajectory out of malaise (for the third time in as many years).

What is really amazing about the idea of a global economic system is that it not only crosses national boundaries, it also penetrates sometimes radically different structures and routines. The economy and nation of Spain is altogether different than the economy and nation of Germany or China. These economic ties cut across languages, vastly different political arrangements and conditions, varying degrees of public sector dependence and dominion, as well as proportional distributions of consumerism vs. business investments and profits, different currencies and pathways for markets to interact and react to monetary flows. The global economy is not a creature of homogeneity, meaning something outside these systems ties the whole mess together.

We are led to believe that the commonality, the unifying link in this global chain of economic interdependence, is capitalism. Therefore, the ebb or wane in the recovery in the middle of 2012 is a failure of capitalism - the system itself must be corrupt from the outset. This line of thinking offers an easy explanation for the apparent failure of "stimulus". By all accounts of conventional economists and the policymakers that adhere to their views, these continued massive doses of fiscal and especially monetary stimulus should have been more than enough. It is bad enough that capitalism was to blame for the collapse in the first place, according to emerging convention, but it is apparently so corrupt and flawed that it doesn't even have the good sense to allow elite opinion to fix it.

In France, new President Francois Hollande has radically altered the economic course of his nation, and has been met by, as he alludes to, cheers from investors. Apparently, even the capitalists favor the return of muscular government. The same day President Hollande said that his proposals were, "...not a choice for an assault of austerity but the choice for the future sovereignty of our country" and pledged to credibly reduce the public debt (through tax increases on individuals in the upper income brackets), his country, for the first time in its history, auctioned off short-term debt at negative interest rates.

In that French bill auction, however, lies the real answer to what forms the basis for the globalized and globalizing system. It cannot be a true capitalist system that is creating negative interest rates throughout the "developed" world since capitalism, at its very core, values capital. Negative interest rates are the very real signal that capital is being destroyed at will. Since this capital destruction is not localized, and does not appear to be temporary, this strongly suggests that some exogenous force (exogenous from the perspective of a system that values capital) is uniformly acting upon the global system in a manner that does not conform to what would fairly be called capitalism.

The imbalance of global trade as seen in the rise of "export economies" were not spontaneously erected and maintained by accident. Germany, Japan or China did not become marginal creatures of their export "prowess" without squaring the circle of trade finance. Currencies had to be rigged and monetary flows had to be managed to ensure that disruptions were minimalized. Imbalances had to be hidden amongst the tide of asset inflation. The drastic flow of productive capacities had to, at all costs, be subsidized by credit production. No matter how much the global economy shifted productive capacity, it was maintained in an inflationary stasis that tied the whole unwieldy system together through the technologic innovation of finance. Any piece that felt the strain of growing imbalance could be rebalanced artificially by financial dominion.

The commonality of economic result among these disparate national systems contained within the exogenously connected global economy is due to the common trait of activist central banks. Today's negative interest rates are the prime signal that money is more valuable than capital, a consequence that only monetarism and financial domination could produce willingly. In all those countries experiencing the renewal of the receding economic tide of re-recession (or just continued depression for simplicity's sake) there sits an activist central bank at its modern core.

As much as the US Federal Reserve Bank gets heaped with praise/scorn for being the very embodiment of activism, that stature is more rightly saved for the Bank of England. In so many ways, the US Fed simply copies monetary policies and procedures that the "Old Lady of Threadneedle Street" has already run-tested in the UK.

For example, Ben Bernanke caused a minor stir in his Congressional testimony last week when he suggested the FOMC might consider using the Discount Window programs to push monetary stimulus directly into the housing market. In an epoch filled with them, it was yet another extraordinary suggestion - a possible Federal Reserve monetary expedition that would bypass the usual methods of monetary expression. Since monetary policy is typically conducted inside the context of interbank wholesale markets, direct lending in this manner would be noteworthy.

For all the new ground such a policy might break in the United States, it has largely been tried already in the UK. Viewing small businesses as deprived of access to the machine of credit production (another commonality amongst the global economic cogs), David Cameron's government launched the whimsically named "Project Merlin" in February 2011. Perhaps hoping for some miraculous wizardry or alchemy, the British government, under the Bank of England, pushed the four largest UK banks plus Santander UK to increase lending, with a particular focus on small businesses. Merlin set specific lending targets for the banks.

The lending target was set for additional gross lending of ₤190 billion in one year. In early February 2012, the banks noted that they had exceeded their lending targets, running up gross lending by ₤215 billion. The small business target was set at ₤76 billion. Actual lending to small businesses missed the target, grossing ₤74.9 billion, but not by much. There were complaints that these lending programs were not offering competitive rates, as well as anecdotal evidence that overall credit demand just was not there. Project Merlin, as you might imagine, has been roundly criticized as a failure.

As a failure, it still has to be said that Merlin met its targets. These five banks lent money to somebody to do something. Maybe critics did not like the terms and there have been the predictable cries that the targets were not high enough (is it ever enough?), but for all intents and purposes Project Merlin did what it was supposed to do - supply credit to the UK economy. And how did the UK economy respond to this lending? By contracting in three of the next four quarters.

The fifth quarter after the start of Project Merlin, and the first after its end, has been most noteworthy. Just announced this week, the UK Office for National Statistics (ONS) estimated that GDP in the second quarter of 2012 fell by 0.7% (it should be pointed out that the UK does not annualize its rates like the BEA in the US; on an comparative annualized basis, Q2 2012 GDP in the UK fell by almost 3%). Analysts were expecting an improvement to -0.2% from the rate of -0.3% in Q1, so by any standard Q2 was a disaster.

Predictably, there have been ruminations and assertions that much of the surprising degree of contraction may have had some root in the Queen's Jubilee holiday (an extra day off is apparently worth half a percent of GDP?) or the oversupply and imbalance of rainy days. Setting aside that discussion, what is relatively clear is that almost every economist and observer, including those in the mainstream, now expect GDP to contract for the full year 2012. No amount of rain or holidays can distract from that.

How does the UK government and the Old Lady from Threadneedle Street respond? The government announced that they are redoing Project Merlin (under a different name, of course) now with a supplement from the Bank of England. The UK central bank aims to subsidize the cost of new loans to ensure a "competitive" rate and, supposedly, competitive access. Apparently small businesses are no longer the problem, though, since this new plan is directed squarely at homebuilding and construction.

The ONS estimates that the construction sector reduced its output by 5.2% in Q2, coming fast on the heels of a 4.9% drop in Q1. Now it is construction, and not small businesses, that are square in the credit illiquidity desert. However, output from the production industry also shrank in Q2, by 1.3%, after falling 0.5% in Q1. Accordingly, it might seem to be another sector that needs its own credit program. Even the service sector contracted in Q2, by only 0.1%, so we should probably expect some policymaker to propose the service sector as still another area for pursuing credit expansion.

Direct targeting of credit in 2011 either failed to work because the scale or amount is never enough, or, far more likely, credit is just not the answer. When the only tool you have is monetary, every problem looks like a lack of credit.

In every corner of the global economic system there is money. There are monetary programs and emergency monetary agendas aplenty. Every patch of weakness is met with an even greater emphasis on money and credit, maddeningly, or confusingly depending on your economic persuasion, to no avail. In so many ways the failure of all this monetary expansion to advance the real global economy is acting as a kind of supra-systemic measure of true intermediation. As central banks and central planners continue to aspire to fix the global economy with the same old credit and debt measures as they have for the past four decades, they are intentionally overriding the role of intermediation and self-correction. Yet the real economy appears to be fighting back, rejecting money and credit as a workable solution.

Intermediation itself is vital to a true capitalist system since real capital has to find a sustainable and profitable use. Out of the noise of the real world, an intermediary must determine which uses of money and capital might conform best to those parameters. Yet for decades now central banks have decided that this monetary discretion is a hindrance to both the imbalancing trade system and the overall global economy. A true intermediary might view the tipping scale of productive capacity as a warning to scale back credit, and thus embed financial consequences to the globalizing system. Intermediation in its purest, most fundamental form would have been an anathema to the yawning disparity of production. A true capitalist system would have resisted the urge to replace the imbalance of global activity under the cover of aggregate demand.

A real capitalist system, featuring true intermediation, would attempt to clear trade imbalances. It would note for correction a system imbalanced by the wrong mix of economic activity or the wrong balance of speculation over investment. Intermediation does not seek to create economic activity for the sake of economic activity. Aggregate demand, on the other hand, does not care one bit about how or why a system produces activity, it is only a quota that has to be met come hell or high water. When in doubt, central banks believe they can always and everywhere fill that quota with debt-based activity.

So central planners, assisted by central bankers, keep setting targets and quotas and keep getting mystified as to why those targets and quotas are utterly useless. The UK largely met its Project Merlin targets, but the economy has still sunk into the despair of persistent dislocation. As much as there is the easy impulse to lay blame at the foot of Spain and Greece, the UK construction industry is only tangentially connected to the PIIGS. There is no doubt that weakness in Southern Europe is a drag on the UK, but if monetarism and credit expansion, especially as they are intentionally targeted to induce domestic animal spirits as a replacement, were really effective the UK economy would be improving despite the weight of Eurozone worries instead of sinking concurrently and coincidentally.

Central banks have played a central role in monetizing the global economy into a system where there are very few places to hide. You can call it contagion if you want, but this marriage of the unnatural disabling of intermediation with the quota system of aggregate demand is the stuff of epic disasters. It is well beyond the concept of liquidity trap into the surreal realm of the death of money. Central banks are shoveling money, or at least promising to, as fast as they can into a system that neither wants nor needs it. All the while the cost of money is driven ever downward. The problem now is that the flipside of cost is "value". As interest rates sink further into negatives throughout a wide swath of the financial system, the value of all that money is largely negative as well. The diminishing returns on money overflow to diminish the potential returns on true capital. No real economy can run on unattractive or negative capital; the system ends up consuming itself through the lack of investment. But a financial economy can, and, as usual, it ends up as the parasitic beneficiary of the misguided global church of monetarism.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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