The Next Wave of Debt Monetization Will Also Be A Disaster

According to the IMF (International Monetary Fund) and the IIF (Institute of International finance) global debt has soared to a new record high. The level of government debt around the world has ballooned since the financial crisis, reaching levels never seen before during peacetime. This has happened in the middle of an unprecedented monetary experiment that injected more than $20 trillion in the economy and lowered interest rates to the lowest levels seen in decades. The balance sheet of the major central banks rose to levels never seen before, with the Bank Of Japan at 100% of the country’s GDP, the ECB at 40% and the Federal Reserve at 20%.

If this monetary experiment has proven anything it is that lower rates and higher liquidity are not tools to help deleverage, but to incentivize debt. Furthermore, this dangerous experiment has proven that a policy that was designed as a temporary measure due to exceptional circumstances has become the new norm. The so-called normalization process lasted only a few months in 2018, only to resume asset purchases and rate cuts.

Despite the largest fiscal and monetary stimulus in decades, global economic growth is weakening and leading economies’ productivity growth is close to zero. Money velocity, a measure of economic activity relative to money supply, worsens.

We have explained many times why this happens. Low rates and high liquidity are perverse incentives to maintain the crowding out of government from the private sector, they also perpetuate overcapacity due to endless refinancing of non-productive and obsolete sectors t lower rates, and the number of zombie companies -those that cannot pay their interest expenses with operating profits- rises.  We are witnessing in real-time the process of zombification of the economy and the largest transfer of wealth from savers and productive sectors to the indebted and unproductive.

However, as monetary history has always shown, when central planners face the evidence of low growth, poor productivity and higher debt, their decision is never to stop the monetary madness, but to accelerate it. That is why the message that  the ECB (European Central Bank) and the IMF are trying to convey is that there is a savings glut and that the reason why negative rates are not working as expected is that economic agents do not believe rates will stay low for longer, so they hold on to investment and consumption decisions. Complete nonsense. With the household, corporate and government debt at still elevated levels and close to pre-crisis highs, the notion of excess savings is ludicrous. What informs such a misinformed opinion? The often-repeated “there is no inflation” fallacy. If money supply is high and rates are low but inflation does not creep up, then surely there must be a savings glut.  False. There is massive inflation in financial assets and housing but there is also a very clear rise in inflation in non-replicable goods and services versus replicable ones, which means that the official consumer price indices (CPI) misrepresent the true cost of living increase. That is the reason why there are demonstrations all over the eurozone against the rising cost of living at the same time as the ECB repeats that there is no inflation.

When central planners blame economic agents for an inexistent savings glut and repeat that there is no inflation when there clearly is a lot,  they also tend to add a conclusion: if households and corporates are unwilling to spend or invest, then the government must do it.  This is, again, a false premise. Households and corporates are spending and investing. There is no evidence of a lack of capital expenditure, let alone solvent credit demand. The private sector is simply not investing and spending as much as governments would want them to, among other reasons because the private sector does suffer the consequences of taking a higher risk when the evidence of debt saturation is clear to all those who risk their capital.

Unfortunately, the next wave of central bank action will be the full monetization of government excess. The excuse will be the so-called “climate emergency” and “green deals”. Yet governments do not have better or more information about the best course of action in the energy transition, and by artificially picking winners and losers, ignoring the positive forces of competition and creative destruction to deliver faster innovation and progress, governments tend to delay, not accelerate change.

In any case, it will happen. The ECB, always happy to repeat the mistakes of Japan with an even stronger impetus, is likely to start new programs of debt monetization for green projects and claim it is a different, radical and new measure… as if it was not doing so already with the Juncker and Green Energy Directives.

The result is easy to predict, unfortunately. Governments hate two things that disruptive technologies do: reduce consumer prices and generate lower tax revenues. Yes, disruptive technologies are, by definition, disinflationary both in CPI and in tax receipts. Furthermore, disruptive technologies also demolish government control of the economy. These three reasons, lower inflation, lower tax revenues, and less control, are the reasons why governments will never adopt true changes in the economic growth pattern. And because of these reasons, the massive spending financed with new money creation is likely to be even worse for economic growth. Not only it is likely to be an even bigger crowding-out of the private sector, but make economies less dynamic, less productive and more indebted.

There are ways to incentivize change and a green revolution. It is called competition and creative destruction. None of those are favored by governments, not because they are evil, but because governments have the incentive to maintain the obsolete sectors via subsidies.

If the previous $20 trillion stimuli have delivered more debt, less growth, and rising discontent among the middle class that always pays for government experiments, the next one will likely be the last step towards full Japanization. If anything, what are already prudent spending and investment decisions from the private sector are likely to be even more conservative, and the resulting negative productivity growth will mean lower salaries and employment but higher debt and a larger size of government in the economy… Which is, in reality,  the ultimate goal of these massive plans.

The reader may think that this time is different but it is not, because the incentives are the same. What I am completely sure is that, once it fails as well, many will demand even more stimuli to solve the problem

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

10 thoughts on “The Next Wave of Debt Monetization Will Also Be A Disaster

  1. Excellent. Not a word wasted. Your concluding prediction is inevitable, of course. I’m reminded of the ancient curse, “May you live in interesting times.” The “you” is all of us. You’re at the top of your class, sir. I always enjoy reading and listening to your worthy analyses. Thanks. Warren Bachman

  2. De facto US debt monetization operations have already started ( CUSIP 912796WL9).
    The FED purchased 10% of the issue from JP Morgan in the same 24 hour period of being issued by the Treasury. Guaranteed profit for JPM.

    Credit to Chris Martenson for posting this data.

    Moral bankruptcy precedes the financial.

  3. Excellent Article. Capture inflation correctly and you see the productivity drop. I don’t think we capture inflation correctly today. I’d like to add the middle class are intimidated by high assets prices and less stable employment and family structure leaving only the very wealthy with access to low interest rates and legal protection through debt structures in case of default to take on the purchase of expensive assets which in turn are used to collect rent increasing the rich poor divide , asset prices, productivity and the increasing protests we see. I think underlying all of this is the change in the population pyramid. We had massive increasing demand due to population growth, that growth has stopped and is going into reverse. When this happened in middle ages the value of labor increased. Perhaps population change will drive up the value of labor and restore a balance. However if central banks keep trying to support the old system this may not be allowed to happen.

    1. Correction – ” increasing the rich poor divide , asset prices, productivity and the increasing protests ” should read ” increasing the rich poor divide , asset prices, REDUCED productivity and the increasing protests “

  4. There are always easy answers to problems, no matter how large if one is willing to look in the right place.

    The proof below confirms that there is no difference to the aggregate of assets, property, and incomes that comprise That Which Funds Gov’t, TWFG, whether government taxes or borrows. I substitute Disposable Income for TWFG, but it makes no difference. 


    Let us say that government shall fund public expenditures in 2 scenarios: Taxation and Borrowing with effects wrought upon the aggregate Disposable Income (Y) of a community. Two time periods, T1 and T2, are required to illustrate, firstly, initial taxing and borrowing and, secondly, subsequent repayment of borrowed funds. Govt. expenditure has a value of G in T1 and nil in T2. Only resident citizens may lend to the government.

    Scenario 1 – Taxation

    T1: Disposable income is Y1 – G.

    T2: Disposable income = Y2.

    Scenario 2 – Borrowing

    T1: Disposable income is Y1 – G = Y1 – loaned Savings (S) = Y1 – S

    T2: Disposable income is Y2 – public debt + loaned savings, both with interest (R) added = Y2 – S(1 + R) + S(1 + R) = Y2 – 0 = Y2

    The Govt under Borrowing is handed a capital charge. It must ensure that benefits to TWFG exceed costs, i.e. that the created and accruing assets of TWFG are enlarged by an amount greater than incurred and accruing liabilities. 

    By abolishing all Taxation, such an outcome is easily achieved. There are 2 great costs in Taxation, govt. squander and deterrence, which disappear with full public and perperual Borrowing. 

    Let us say there is an economy of 100 units – 40 units seized by government through Taxation and 60 units left to the population. With Taxation abolished and government forced to borrow directly from the public, the costs of Taxation, squander and deterrence, disappear.

    With deterrence erased, let us say the economy grows to 130 units. With squander erased the government share declines to 20 units.

    So which economy should one prefer?

    One of 100 units in size that leaves 60 units to its people? Or an economy of 130 units that leaves 130 –  20 or 110 units to the same?

    Not a difficult choice is it?

    The public or TWFG is enriched by full Public Borrowing as is the public credit.

    It’s no longer a question of debt or no debt, but rather a question of assets and liabilities, just as it is for any firm, bank or person. As long as the former exceed the latter, none is worried about the security of their funds, and there is no need for Taxation. 

  5. »» No savings glut ««

    Why is there a bid for bonds yielding nothing or less if there is no savings glut?
    Massive debt is not the opposite of saving. All bond (savings) are also a debt.

    Despite all the wailing and gnashing of teeth, you should step back a moment and ponder how you expect the economy to distort due to the demographic bulge of boomers on the verge of retiring. People are desperate to buy fixed income. The government is exacerbating that by competing for bonds, which makes it even more expensive to buy fixed income. If interest would be higher, people wouldn’t have to pay so much for a little bit of fixed income.
    It is a mistake to think of the economy as an equilibrium state. We should expect people to be bidding up assets in an attempt to build pensions. Economists/governments are rowing against the tide with their low interest bond buying. When boomers die, those assets will flow back into the market at bargain basement prices.

    Governments should be borrowing (cheaply) and investing in future production/infrastructure. Boomers would buy the bonds (fixed income), and extra capital assets (infrastructure/production) will come in very handy when the work force starts to shrink and those boomers need eggs and bacon.

    1. You answered yourself. None of that is fueled by savers’ demand but by central bank absorbing lowest-risk assets through debt monetization. If central banks were not buying those bonds the yields would soar. No savings glut. just financial repression.

  6. Great reflexion about the present, thanks for it. Any impositive thing have not the proper correction, they do not care, because as you said, are looking grow the bureaucracy.

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