Central Bank Failure Is Being Exposed

The global growth slowdown now looks contagious. China has been slowing for the past several years. The Chinese government has tried monetary ease, currency manipulation and bank lending mandates to prop up growth, but it’s not working. Chinese corporate defaults are on the rise. The situation in Europe is no better with Italy, France and Germany all coming close to recession and with continued declines in the forecast.

The U.S. has been doing better than Europe, but the trends are not encouraging. Q4 2018 GDP was just revised downward from 2.6% to 2.2% and Q1 2019 GDP is currently estimated at 1.7%.

With Europe, China and the U.S. all in slowdown mode, what else could go wrong?

The answer is Japan. Many signs are emerging that Japanese growth is slowing and a recession may be on the horizon.

The latest Bank of Japan business confidence survey hit a two-year low. Other surveys are showing additional signs of slowing or negative growth. Japan is planning a major sales tax increase this year that may give the economy a temporary lift (as consumers rush to beat the tax increase), but will end up slowing the economy once the tax is in place and the accelerated demand comes to a grinding halt.

I have repeatedly reported on growth warnings from well-respected institutions including the IMF, the Bank for International Settlements and leading academics. The point was to make it clear that economic weakness is not a fringe view but something the elites themselves are deeply concerned about. Now comes perhaps the most authoritative warning of all.

World-famous investor Warren Buffett, ranked among the richest people in the world, recently told CNBC that “the pace of increase in the economy has slowed down.” He bolstered this claim by reporting that his BNSF freight railroad, which transports oil from Canada in addition to many other loads, is showing signs of slower growth.

Transportation indexes typically lead broader stocks indexes when it comes to turns in the economy. None of this anecdotal evidence points definitively to a recession, but the U.S. is unquestionably closer to a recession than at any time since the current expansion began in 2009.

The head winds to growth are coming from many directions, including trade wars and demographics.  Get ready for synchronized global declines in growth and perhaps a global recession in the year ahead.

Meanwhile, the Fed is conducting what still remains tighter monetary policy through “quantitative tightening,” or QT.

The Fed’s balance sheet, which rose from $800 billion to $4.5 trillion under QE, has since been reduced to about $3.9 trillion through QT. Though it is expected to end in September, for now the Fed continues to trim its balance sheet.

Yes, the Fed is on pause when it comes to rate hikes. But it is now facing the consequences of its previous tightening, which started back in Dec. 2015 and accelerated in Oct. 2017 with the onset of QT.

But it may have waited too long to reverse course. As I warned repeatedly, its previous tightening through higher rates and reducing the money supply has pushed the U.S. close to recession. Now, it is backtracking. The Fed has realized its mistake and has lately paused its rate hikes, along with preparing to end its QT program.

But as I’ve explained many times, the rate hikes and QT were designed to normalize rates and the Fed’s balance sheet in preparation for the next recession.

Historically it takes about 4% in rate cuts, or “dry powder” to pull the economy out of recession. But rates are currently frozen at 2.50%. How can the Fed fight the next recession if it can’t raise rates above current levels? It can’t.

But the Fed is not alone. Other central banks have not been able to normalize. Japan continues to keep rates below zero and has purchased large quantities of Japanese government bonds, stocks and other securities. The European Central Bank (ECB) also has negative rates and continues a QE policy.

In short, all of the Big Four global economies — the U.S., China, Japan and Europe — are slowing and monetary policy seems helpless to stop the decline.

What does it all mean?

It may be the case that monetary tightening is impossible without recession and that central banks may be stuck at zero (or, in the Fed’s case, returning to zero) in order to prop up growth. Essentially, rates may be zero indefinitely. That may sound inconceivable, but it’s a strong possibility that must be considered.

The Fed has been trying for over 10 years and has met with failure. Look at its inflation targeting. It took the Fed six years, from 2012–18, just to get inflation to their target of 2%, at which point it promptly fell back to 1.9% and will probably trend lower in the months ahead.

The reason inflation has not emerged is because inflation is not driven by money supply alone. Money supply is dry tinder, but it won’t start a fire.

Inflation is driven by demographics and behavioral psychology — two phenomena the Fed and other central banks cannot control. The world today is inherently deflationary due to debt, demographics and technology. Central bank money printing has no material impact on those factors.

But if that’s the case and if governments want to stimulate their economies, they may have to resort to deficit spending monetized by the central bank. This formula is known as “Modern Monetary Theory,” or MMT.

This theory says that the U.S. can spend as much as it wants and run the deficit as high as we want because the Fed can monetize any Treasury debt by printing money and holding the debt on its balance sheet until maturity, at which time it can be rolled over with new debt.

MMT has been in the news a lot lately, and it’s been steadily gathering momentum. Democrats are counting on MMT to finance some variation of a Green New Deal and their other programs, including Medicare for All and free tuition.

MMT advocates will say that Bernanke printed $4 trillion from 2008–2014 to bail out the banks and help Wall Street keep their big bonuses. There was no inflation. So why not print $10 trillion or more to try out these new programs? What’s the problem?

I’m actually having a debate tomorrow with a leading MMT advocate, which I hope to win. That’s because MMT proceeds from a false premise, namely that money is a creature of the state and derives its power from the fact that people need money to pay taxes.

But I argue that money depends on trust, not coercion. And trust in the monetary system can be broken if people fear massive inflation, as is the case in Venezuela today, for example.

The inevitable result of MMT is inflation. Investors should prepare now for an inflationary outbreak if MMT is pursued. That means owning physical gold, silver, land and other hard assets that will protect you against the ravages of inflation.

Once the inflation begins, it’ll be too late to take precautions.


Jim Rickards
for The Daily Reckoning

The Daily Reckoning