I couldnâ€™t think of a better way to start out a speech focusing on current economic circumstances. But given these words were uttered by a central bank governor, you can be rest assured that the speech that comes next will be nothing short of vague pronouncements over a lack luster growth, slightly optimistic forecasting, and, above all, deflecting blame for any of the current difficulties the global economy is facing.
In the type of speech all too familiar to any modern day central banker, Mark Carney, Governor of the Bank of Canada, goes through the motions of waxing on about the rough road ahead for a country facing an increasing private debt load and threat of accelerated deleveraging occurring both domestically and abroad. While Carneyâ€™s speech contains a number of revealing points (a mercantilist devotion to Canadaâ€™s export industry, an ironic criticism of currency rate manipulation by- read China- emerging markets, a Keynesian advocation for sustaining aggregate demand, etc.) I will only concentrate on the speechâ€™s focus of debt deleveraging.
In regards to global debt amassing, Carney remarks:
Accumulating the mountain of debt now weighing on advanced economies has been the work of a generation. Across G-7 countries, total non-financial debt has doubled since 1980 to 300 per cent of GDP. Global public debt to global GDP is almost at 80 per cent, equivalent to levels that have historically been associated with widespread sovereign defaults.
This is certainly true. Private debt has skyrocketed in many industrialized countries for the past three decades. Take one look at the growth in household debt in the U.S.:
No mention of the source of this debt accumulation yet; Carney is too wise for that. He makes note of the public sectorâ€™s seemingly indisputable symbiotic relationship with private debt loads and shockingly declares that, â€œprivate defaults often mean public rescues of banking sectors; recessions fed by deleveraging usually prompt expansionary fiscal policies.â€ To Carney and his central banking peers, bailouts and Keynesian fixes are treated as unquestionable. The political class has found comfort in preserving the status quo despite almost universal outrage by taxpayers over bailouts. Kicking the can is no longer treated amongst various options; itâ€™s the only option. Taking the bitter medicine of a market correction never bodes well for reelection, or reappointment, so the narrative must be constructed as rigid with no alternatives.
Carney then proceeds to charge the free market with being unable to manage debt without proper oversight. What he really means is that individuals, who compose the metaphysical idea of the market, are incapable of managing their own debt. In Carneyâ€™s eyes, it is up to wise and prudent regulators to ensure that the trains run on time and John Q. Public doesnâ€™t run up his credit card bill or purchase a home he canâ€™t really afford. Friedrich Hayekâ€™s concept of â€œfatal conceitâ€ remains alive and well in the minds of central bankers. Where these intellectually gifted regulators were just a few years ago, Carney doesnâ€™t reveal. But of course they were riding the wave of optimism due to the exact impetus for debt leveraging we will get to soon.
In what has to be one of the most nonsensical and counterintuitive statements since Lawrence Summers, former economic advisor to U.S. President Obama and former President of Harvard University, declared that though the financial crisis was caused by too much confidence and debt run-up, the cure involves more of the same imprudent spending habits, Carney offers this muddled statement:
The challenge for the crisis economies is the paucity of credit demand rather than the scarcity of its supply. Relaxing prudential regulations would run the risk of maintaining dangerously high leverageâ€”the situation that got us into this mess in the first place.
Read it twice for the full effect. You see, the problem isnâ€™t a deficiency of available credit; central banks around the world have made sure of that. Itâ€™s the demand for credit that remains an albatross on a robust spending boom. Yet, and this is the best part, regulations that ensure that credit expansion, a driving force in fractional reserve banking, doesnâ€™t finance more reckless debt amassing canâ€™t be expunged as it would lead to another deleveraging bust.
Carney wants his cake and to eat it too. While he warns of lack of credit demand, he also worries that an increase will lead to another boom and bust. This double talk- wanting success while worrying about too much success- is typical central banker speech.
Carney is not alone in this sentiment. Public officials all over the world, namely in the U.S. and Europe, are desperate for a return to the boom years. The drug of easy credit and debt monetization had them addicted to the good times.
Like any good central planner, Carney speculates on how to best unwind the private debt load in order to run it up again. He paints himself as a deep thinking central planner struggling to find the exact formula where the BoC can use its printing press and discover the perfect equilibrium for credit expansion without blowing up another bubble.
Over the same period, Canadian households increased their borrowing significantly. Canadians have now collectively run a net financial deficit for more than a decade, in effect, demanding funds from the rest of the economy, rather than providing them, as had been the case since the Leafs last won the Cup.
It cannot entirely be business as usual. Our strong position gives us a window of opportunity to make the adjustments needed to continue to prosper in a deleveraging world. But opportunities are only valuable if seized.
First and foremost, that means reducing our economyâ€™s reliance on debt-fuelled household expenditures.
Though Canada saw tremendous growth with public spending reforms adopted in the mid-1990s, the cyclical pattern of private overindebtedness has begun to rear its ugly head. This isnâ€™t unexpected as the BoC, like central banks all over the world, took interest rates to anorexic levels following the financial crisis of late 2008. As I have noted, this orthodox reaction has set the stage for what looks like a housing bubble that will inevitably pop. Even Carney alludes to such as he states one of the hallmarks of the Austrian Business Cycle theory where the discoordination brought on by credit expansion leads to malinvestment in specific capital ventures and consumer goods:
Moreover, much of the proceeds of these capital inflows seem to be largely, on net, going to fund Canadian household expenditures, rather than to build productive capacity in the real economy. If we can take one lesson from the crisis, it is the reminder that channelling cheap and easy capital into unsustainable increases in consumption is at best unwise.
When the day of reckoning arrives, the market correction will undermine an already flimsy recovery. Not only will private balance sheets containing mortgages and real estate take a hit due to reduced prices but also the Canadian Mortgage and Housing Corporation will be ravaged as it guarantees about 90% of the whole housing market. As Chris Horlacher points out, the CMHCâ€™s leverage stands at almost an astounding 100:1. A burst of the housing bubble will likely require a massive bailout via the Canadian government to keep the CMHC functional which in turn will require further debt monetization. The probability of this chance event coming to pass is further emphasized by Carneyâ€™s earlier comments on the inseparable nature of the private sector from governmental dominance.
While Carney spends a great deal of time laying out the predicaments the global economy is facing, he spends zero time acknowledging the role central banks have in perpetuating these difficulties. The continual and desperate manipulation of interest rates to spur growth is ignored. Carney is a master of pointing the finger at profligate governments and individuals without addressing the core issue at hand. Without a central bank ready and willing to use the printing press to engineer credit expansion, a sustained period of leveraging cannot occur without interest rates spiking. Price signals serve as not only a means to direct investment to those sectors which demand it but also to put a limit on an overextension resources devoted to unsustainable lines of production. The increase in cheap debt canâ€™t continue without further inflationary pressure manifesting itself over the whole economy. This is the marketâ€™s mechanism for regulating credit supply. For now, with relatively stable Consumer Price Index numbers, it seems like Canadaâ€™s cheap credit has made its way into home prices. As Carney slyly admits in a footnote to the speech, the prospect of curtailing ultra low interest rates in light of further inflation would â€œexacerbate unfavourable debt dynamics.â€
Ludwig von Mises, writing in Human Action, describes this rock-and-a-hard place dilemma:
The inescapable consequences of credit expansion are shown by the theory of the trade cycle. Even those economists who still refuse to acknowledge the correctness of the monetary or circulation credit theory of the cyclical fluctuations of business have never dared to question the conclusiveness and irrefutability of what this theory asserts with regard to the necessary effects of credit expansion. These economists too must admit and do admit that the upswing is invariably conditioned by credit expansion, that it could not come into being and continue without credit expansion, and it turns into depression when the further progress of credit expansion stops.
The lesson learned here is that bubble-producing exuberance is not the cause of a dysfunctional financial system but only a natural reaction to the policies of central banks. Carney even attempts to lay blame on capital inflows into the country despite the economic fact that purchases of government and corporate bonds must be paid for with Canadian dollars; which means an increasing supply of Canadian dollars must fund these transactions less a decrease of prices in other goods.
The run up of debt in industrialized countries over the past three decades was both a function of fractional reserve banking, governments predisposed to easy credit, and central banks perfectly willing to serve as an enabler to the whole scheme. Canada was no different as the consequences will differ only timing. Massive deleveraging, as painful as it will be, is the only real solution for cleansing an economy of all its zombie debt.
If Carney was truly worried about excessive debt, he wouldnâ€™t fear a correction and continue giving away money for almost nothing with record low interest rates. Itâ€™s the equivalent of leaving out hard liquor in the presence of an alcoholic and then chastising him for giving in to temptation.
Carney is still correct on one issue. These really are â€œtrying times.â€ But such dire economic conditions are not the result of an unstable private sector or inept central banking but of central banking itself. Carneyâ€™s speech is wholly reminiscent of the kind of awe-inspiring bravado which former Federal Reserve chairman Alan Greenspan employed to charm U.S. Congressmen. In too many words, he says nothing short of â€œitâ€™s everyone elseâ€™s fault but mine.â€