Cheap Money Isn't

A must-read think-piece from Tyler Durden on how central banks around the world are inadvertently creating deflation when what they’ve been trying to do is inflate their various currencies:

On Saturday we once again explored the question of whether central banks are creating deflation. The idea that post-crisis DM monetary policy may be causing disinflationary pressures to build is somewhat counterintuitive on its face but in fact makes quite a lot of sense. Here’s how we explained it:

The premise is simple. By keeping rates artificially suppressed, the central banks of the world effectively make it impossible for the market to purge itself of inefficient actors and loss-making enterprises. As a result, otherwise insolvent companies are permitted to remain operational, contributing to oversupply and making it difficult for the market to reach equilibrium. The textbook example of this dynamic is the highly leveraged US shale complex which, by virtue of both artificially low borrowing costs and the Fed-driven hunt for yield, has retained access to capital markets in the midst of the oil slump and has thus continued to drill contributing to the very same price declines that put the entire space in jeopardy in the first place.

Expanding upon that a bit, we might say this: those who have access to easy money overproduce but unfortunately, they do not witness a comparable increase in demand from those to whom the direct benefits of ultra accommodative policies do not immediately accrue.

“When you’re up to your ass in alligators,” the saying goes, “it’s difficult to remember that your initial objective was to drain the swamp.”

It’s fascinating stuff from Zero Hedge, and while perhaps it doesn’t tread much new ground, it does a fine job of tying many of our various economic troubles together into one piece.

I’d add one more thought to help complete the even broader picture.

Prices, as we all learned in Econ 101, are just information, the data which allow producers and buyers to make informed decisions under ever-changing conditions. Governments screw with prices — that is, they mess with the data — all the time. They subsidize this thing, the tax the bejeebus out of that thing, they mandate another thing. When prices reflect what government wants, rather than what producers require or what consumers desire, then poor decisions are made by all parties.

The housing bubble is a fine case in point. Washington made the political decision that riskier home loans shouldn’t be priced any higher than less-risky home loans. Banks had to do something to pass along the risk, and so credit default swaps were created to peddle the high-risk loans to the secondary market, right alongside the solid loans. Investors bought into this madness, and everybody enjoyed the boom right up until it went bust — and nearly brought down the entire global economy with it.

That’s not to say individuals and business don’t make bad decisions — they do it all the time. The late ’90s tech bubble is a prime example of just that, as seemingly everybody got caught up in the dotcom frenzy, fueled in part by massive equipment upgrades. Everybody needed new computers to run the new 32-bit Windows upgrades, and lots of old equipment needed replacing to avoid the Y2K bug. Then the upgrade cycle ended and the dotcom profits never materialized, and the boom went bust.

But there’s a major difference between those two bubbles.

When the Dotcom Bubble popped, we were left with all that awesome new equipment and software, and the internet companies which survived were largely the smart and efficient ones. The underlying economy was still just as fine as it ever was.

To really screw things up requires government intervention, like we saw in the housing bubble. That bubble diverted more than a trillion dollars — a trillion! — away from productive investments in new businesses and new technology, and towards giant houses few people really needed and, as it turned out, fewer still could afford. The result, as I said, nearly brought us Great Depression II: Home Loan Boogaloo.

I haven’t been able to find a study backing this up, but my gut tells me that the housing bubble is also responsible in large part for our lame productivity gains since the turn of the century. You can’t suck a trillion investment dollars out of productive industries and stick it into vanishing home values without taking a hit to productivity.

Interest rates are the “price” of money — the information borrowers and lenders need to make smart decisions. But our central banks have decided that in these troubled times, money should be essentially free. But nothing makes people crazier or stupider than free money.

That’s what Zero Interest Rate Policy means, that’s what Quantitative Easing does. Banks don’t have good information, borrowers don’t have good information, central bankers don’t have good information, but all three are letting the free money flow like crazy, trying to convince scared (and scarred) consumers that this time the bubble won’t pop.

And so we have commodities producers chasing shrinking profits on ever-greater outputs. The result this time could very well be Great Depression II: Commodities Boogaloo.