Since 2008 financial crisis, the central banks of the USA, Japan, UK, China and the ECB have pumped $18 trillion dollars into the world economy in order to try and stimulate growth.  The chosen method of this so-called Quantitative Easing has been for the central banks to buy up government bonds from the cash-strapped banks with newly hypothecated money. 

This has two effects, firstly it gives the banks quick access to ready cash, and secondly it increases the secondary value of Government bonds, allowing implied interest rates to drop and allowing the Government to continue to tap the markets to fund their borrowing. 

The ‘logic’ behind this approach is that the commercial banks will not fail and will have more money to lend to firms, thereby generating wealth and growth. Also, it allows governments to spend on investment programmes, keeping people off the dole, and recycling the money back into the spending economy.  If you like, it is a short injection of cash to keep the market ticking over until growth returns, allowing for a contraction of cheap money.

In the UK this approach has been exaggerated by the Coalition’s Help to Buy scheme which is pumping £20 billion into the property market, a market that, according to the Office of National Statistics had already reached its 2008 peak by July last year – well before the scheme became active. This despite the fact that the UK economy is smaller now than it was in 2008 and that disposable wages have been eroded by inflation.

In other words, the Government has been lending to banks so they can lend to people who are less able to repay the loan than they were when the debt crisis bit. The total value of this mortgage debt combined with other household loans now stands at over £1.4 trillion

The state, too, has been enjoying the low rate environment that it has created, with UK Government spending rising from £582 billion in 2008, to £719 billion this year – and forecast to hit £741 billion next year. This borrowing is sat upon a national debt that has nearly tripled from 2008 when it stood at £530 billion to almost £1.4 trillion now. The annual debt repayments on this overdraft stand at £47 billion a year and are scheduled to increase by over 40% by 2018.

And it is not just to house buyers and Government that the banks have been lending to; loans to the least loan worthy (high yield) companies in Europe have soared to £123 billion in 2013 – an increase of 56% on 2012. UK banks are the biggest lenders.

The money has also been flowing overseas in what is called a ‘carry trade’.  Put simply, the carry trade means that you can borrow cheaply in the US and lend it more richly overseas.  Generally carry trades keep a sense of rate equilibrium around the world, and offer mutual benefit.  But the global ‘stimulus’ packages have sent the whole world into a debt frenzy, as this chart shows:

Global markets

All this relies upon either the central banks keeping the printing presses rolling out fresh new money, or a return to proper growth. Global growth keeps eluding us. Yet America has decided that its ‘recovery’ is sufficient to begin scaling back its free-money machine in a move called ‘tapering’. Tapering means that the US is going to gradually phase back its market support. 

It has announced that it will buy $10 billion less of its own bonds and mortgage guarantees starting this month.  This effectively means that there will be $10 billion less demand in the market for debt, and this causes the price of bonds to drop. As bond prices drop their ‘yield’, the implied interest rate increases. In other words, action by the US Federal Reserve is putting up interest rates, and declaring its crisis over so that interest rates can normalise.

As US rates rise, the carry trade becomes less desirable, and money is repatriated. Typically, the first places to have funds withdrawn are the riskiest countries; as the dollars go back home, their domestic currencies slump. We are already seeing this: since February last year, the Indonesian Rupiah has depreciated by just under 30%, the Argentinian Peso by 60%, the Chilean peso by 20%, the Indian Rupee by 17%, and the Turkish Lira by 28% amongst others.

The borrowing nations can try and stem the flow by raising overnight rates or by buying their own currency, tactics that sunk the Major Government and made George Soros a rich man in 1993. The commodity exporting nations like Chile face further problems as the Chinese economic slowdown continues reducing their demand for copper, coal, aluminium etc. In addition, these countries now have to pay higher prices for their oil and coal, both of which are priced in dollars. So, once the crumble begins it gathers pace very quickly, soon becoming a full blown financial crisis of its own.

As the losses mount in the developing nations, the UK’s banks will suffer increasing loan dereliction rates. As their overseas loan book depreciates, their capacity to lend domestically will decrease too, starting with a capacity withdrawal from the higher yield (riskier) corporates. As funding dries up at these companies, job losses will result, leading to mortgage defaults and a property crash, leading us right back to where we began. At around 14% of GDP, the economic well being of the banks is paramount to the UK. And, as the FT showed, our banks have a massive exposure. Once the banks go, so do we.

There is no doubt that the root cause for this fast occurring financial crisis is the Government and its feeble grasp on economics. It fueled the banks with cheap money to create a credit boom both here and abroad and caused a catastrophic drop in savings. Savings were probably the only thing that could have averted this unfolding crash, but they were deliberately targeted by governments who, despite what Mr Cameron keeps saying, thought that you could borrow your way out of debt.

Print Friendly, PDF & Email