This Is The Collapse That Is In Front Of Us

As countries get ready to reopen around the world, this is the collapse that is still in front of us.

The path to monetary collapse
(King World News) – Alasdair Macleod:  Few mainstream commentators understand the seriousness of the economic and monetary situation. from a V-shaped rapid return to normality towards a more prolonged recovery phase.

The fact that a liquidity crisis developed in US money markets five months before the virus hit America has been forgotten. Only a rising gold price stands testament to a deeper crisis, comprised of contracting bank credit while central banks are trying to rescue the economy, fund government deficits and keep the market bubble inflated.

The next problem is a crisis in the banks, wholly unexpected by investors and depositors. At a time when lending risk is soaring off the charts, their financial condition is more fragile than before the Lehman crisis. Failures in European G-SIBs in the next month or two are almost impossible to avoid, leading to a full-blown monetary and credit crisis which promises to undermine asset values, government financing and fiat currencies themselves.

We can now discern the path leading to the destruction of fiat currencies and take reasonably guesses as to timing.

How central banks view the current situation
The financial world is bemused: what is it to make of the economic effects of the coronavirus? The official answer, it seems, is on the lines of don’t panic. The earliest fears of millions of deaths have subsided and in the light of experience, a more rational approach of easing lockdown rules is now being implemented in a number of badly hit jurisdictions. Whether this evolving policy is right will be proved in due course. But the motivation is moving from saving lives to restricting the economic damage.

While I am a critic of the inflationist policies of central banks, it is always valuable to look at monetary policy from a central banker’s point of view. Last Friday, Andrew Bailey, the new Governor of the Bank of England, gave an interview to Chris Giles of the Financial Times, where he spoke frankly and reasonably freely about the challenges the Bank faced in common with other major central banks.[i]

Regarding inflation, from his comments it is clear Bailey defines it as changes in the general level of prices, which is hardly surprising, since central banks are mandated to target it. He believes that the rate of price inflation will fall towards zero, citing recent moves in the oil price as a major factor, though the oil price has since recovered. This gives him room to use monetary policy to its greatest extent.

His view was that monetary policy would minimise what he called “scarring”. This is the new buzzword for economists who generally dismiss the economic effects of the current crisis as being temporary, as in when it heals the only evidence left will be a scar. In other words, some overindebted businesses will fail and others would be victims to changes in consumer patterns once normality returns. Therefore, the working assumption is that once the coronavirus crisis is behind us the economy would broadly return to normal, and while he didn’t specifically say it, he expectats is a V-shaped recovery, possibly with a moderate time element to it.

The bank is undertaking a £200bn programme of quantitative easing, which amounts to two-thirds of Britain’s expected funding requirement relating to the coronavirus, in order to satisfy the following policy objectives:

• To stabilise financial markets, buying £50-60bn of gilts every month, in common with actions of other central banks in their markets. This suggests the economy is expected to be on the way to recovery by late-July.
• To reassure the market that extra government debt would be absorbed and to smooth the profile of overall government borrowing. This will enable the bank to keep gilt yields low, and those of corporate bonds as well.
• To meet economic objectives. In other words, pursue a Keynesian policy to return to full employment.
• To address counterfactual issues that can be expected to arise if the Bank did not do QE. Presumably, other than disrupted markets Bailey was referring to fears of deflation in the absence of monetary stimulus.

If Bailey is right and QE of £200bn will see the British economy through the crisis, then that £200bn will be an addition of a little more than 10% to the national debt. The addition to February’s M3 money supply is 6.8%, which is hardly a problem. But there will be trouble if he is wrong, glitches that could arise from one or more of three sources. If other central banks, principally the Fed, dilute their currencies by a larger amount proportionately, the effect on commodity prices, particularly agricultural products, could be to drive them up in sterling terms, helping to undermine sterling’s purchasing power for life’s essentials. Secondly, 28% of gilts in issue are owned by foreigners, who, needing the money in their own currencies, are likely to turn sellers. The third threat is of systemic failure, requiring extra expenditure to rescue one or more major banks and to manage the fall-out.

There is little doubt that Bailey’s thinking is shared by his counterparts in the other major central banks. Besides the threats listed above, the mistake is to simply assume the economy is an entity that does not change materially over time. While seeming an innocuous mistake, it leads to the belief that there is a normality to which to return. Bailey dismisses the problem by saying some businesses won’t survive, and others might have to change. But he is clearly banking on a return to normal, when there is no such thing. It is the proper function of economic, monetary and credit analysis to divine the benefits and threats that make the future different from the present.

Issues of credit
By definition, central bankers do not fully understand credit cycles, otherwise they would have done something to fix their disruptive nature long ago. Instead, they believe in business cycles, which central bankers view as disrupting monetary policy, thereby muddling cause with effect. Conveniently for state organisations, central banks place the blame for irrational behaviour on the private sector. The banks, so obviously the cause of credit cycles, are seen to be merely responding to changing business conditions and must be discouraged, in their own interests, from making the situation worse at a time of periodic crisis.

But central bankers play their part in credit instability by encouraging banks to extend credit to stimulate the economy in the first place. That fact alone makes it nearly impossible for them to accept the consequences of their monetary policies. Central bankers like Andrew Bailey not only look at bank credit through the wrong end of the telescope, but they do not see a credit crisis in the making. This amounts to an ignorance that explains why they believe that the coronavirus is simply a one-off hit, and after a short period of time, everything can return to normal, so long as the recovery is properly managed.

Their simplistic approach does not explain the liquidity stresses in the US banking system that surfaced last September, long before the virus had infected anyone. It does not explain why the Fed was forced to abandon its attempt to reduce its balance sheet, over five months before the first virus casualty occurred in the US. It ignores the consequences of the tariff war between America and China, which collapsed international trade by the beginning of 2019. Central bankers have been blind to evidence that the world was already tipping into a recession, and that commercial banks were, and still are, dangerously leveraged in the face of escalating loan risk.

The bureaucrats in central banks and banking regulatory bodies believe they have insulated commercial banks from the extreme risks of over-lending. Since the Lehman crisis, rules and compliance measures have been put in place designed to reduce these systemic risks, and periodic stress tests have been run from time to time to establish the level of existing risk. Unfortunately, stress testing appears to be designed not to expose systemic weakness but to confirm it no longer exists.

A new paper by Dean Buckner and Kevin Dowd has examined the current position of UK banks, which is instructive in the wider sense about the relationship between central banks, regulators and commercial banks. It concludes that “the core metrics of the Big Five UK banks have deteriorated sharply since the New Year, and even more since the end of 2006, i.e., the eve of the Global Financial Crisis.” It goes on to say,

“The BoE’s ‘Great Capital Rebuild’ narrative about a strongly recapitalised UK banking system is little more than an elaborate, and occasionally shambolic, window dressing exercise. The BoE focused most of its efforts on making the banking system appear strong by boosting banks’ regulatory capital ratios instead of ensuring that the banking system became strong through a sufficiently large increase in actual capital meaningfully measured. The result is that the UK banking system enters the downturn in a worryingly fragile state and avoidably so.”

The authors did not spring this on Britain’s central bankers and regulators all of a sudden. For almost a decade, Professor Dowd has written and co-authored papers warning of the inadequacy of official attempts to strengthen the resilience of the banking system to systemic shocks. And now, a weaker banking system is tasked with supporting the non-financial economy, where lending risk is soaring off the charts.

It is not just the UK banking system that’s in trouble. While the Buckner & Dowd paper confines itself to UK banks and there are differences in the detail, we know that banking regulation is standardised across borders, and the motivation for stress tests to see no evil is common to other major central banks. A central point, missed by most observers, is that the markets are telling us there is a banking crisis already, with bank share prices significantly lower than book values.

The authors go further, pointing out that the relationship that matters most is between total assets and market capitalisation, the true forward-looking value independently placed on a bank in the markets instead of a static accounting figure for shareholders’ capital in the balance sheet. In the case of Barclays Bank its assets relative to market capitalisation gives a leverage for shareholders of 62 times at a time of increasing lending risk. Put another way, additional loss provisions of only 1.6% of the balance sheet asset total wipes out the bank’s market capitalisation. Major Eurozone banks are in a similar or worse condition, as shown in Table 1, of all UK and European designated and listed global systemically important banks (G-SIBs). The G-SIBs are meant to have extra capital buffers to lessen the likelihood of a repeat of the Lehman crisis.…..More Here

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