The West is out of options and out of time

AP/Thanassis Stavrakis

While oil has arrested its march toward $20 at $32 due to short covering, it is worth a pause to see where the next leg down may lie. In short, the long-term picture isn’t pretty: 2008 was potentially just a warm-up.

It is clear that we are heading toward a global recession.  The 2% U.S. growth expected by economists and the IMF is a pipe dream. The EU will be in a deep recession by June and while the UK plans to vote for exit, the world’s finger will hover over the dollar “sell” button at the nightmare prospect of a Trump presidency. The dominoes are primed to fall. However, these warning signs are not just rooted in a little market volatility or depressed oil prices—instead, there are structural shifts underway that pose dangers to our way of life I haven’t seen at anytime in my career.

A hint of the larger problem lies in global central banks’ failures to drive either growth or inflation in any capacity. Granted, intervention was necessary to avoid another Great Depression in 2008. I’m still not sure those outside of Wall Street understand how close to the brink we were then, or how close we are now. The continued intervention, including Japan’s recent adoption of negative interest rates, has set the stage for the next crisis of confidence rooted in central banks balance sheets and the starting pistol will be currency devaluations.

Before understanding the nuance of bilateral currency swaps and the emerging crisis, it is worth recognizing that structural societal problems, rather than asset valuation problems as in 2008, are the driving problem now. This is fundamentally a different crisis.

Domestic European economic demand will never increase as long as waves of immigrants lands on its shores looking for safety from a Middle East in existential conflict. Meanwhile, Riyadh has begun to build the world’s largest skyscraper in Jeddah; 3200 feet is very tough to justify with WTI at $32 and heading lower. In other troubling European news, Norway’s prime minister Erna Solberg has introduced legislation this week that will allow Norway to renounce the Geneva Convention in preparation for the “collapse” of Sweden. The EU is coming apart at the seams and will only worsen as the UK’s June vote approaches.

Back stateside, General Motors had to sell long term bonds just to make pension payments. Across the United States, private pension plans are unfunded by just under a half trillion dollars—numbers that stand to move higher as asset returns underperform actuarial assumptions. That’s just corporate America’s problem, right? Nope. In 2014, the little-noticed Kline-Miller Act passed Congress, allowing corporations to tell the U.S. Treasury they are insolvent and simply cut benefits in half. Just a few years from now, retirees are going to have the rug pulled out from under them through this back door.

Europe is approaching failed experiment status, the world is aging and insolvent, and the last institution in place to arrest severe asset drops is no longer able to effect outcomes.  In a world on fire, investors want to own dollars, and rightfully so. This year alone, the dollar has risen over 25% relative to the rest of the world’s currencies. This is where the problem lies: Central banks with dollar currency pegs and the currency swap lines they have in place to maintain those valuations.

Probably the single most important piece of research on this topic is the currency swap interactive published by the Council on Foreign Relations’ Benn Steil and Dinah Walker. They argue that at the height of the crisis, central banks set up swap agreements so that banking institutions in each country can have access to currency if commercial banks stop lending across national boundaries. These temporary measures have now become permanent, continuing to expand to to nations both large and small in an ever-growing Charlotte’s web, all in the hopes of staving off eventual economic slaughter.

AP/Thanassis Stavrakis

With the dollar racing higher, countries with dollar pegs have to use central bank foreign currency reserves to defend those pegs in the open market. This works until they run out of cash. With oil likely low for years, this puts enormous pressure on both China and Saudi Arabia to devalue relative to current pegs to sustain domestic economic growth. The existing web of swap lines make it easier for central banks to access currency reserves longer than they could under normal circumstances and puts other nations at risk because of the interconnectedness of those lines. So why doesn't the market price this massive risk in the form of lower asset prices? Because all of this activity largely goes unseen by everyone except the Bank of International Settlements (the central banker’s bank), and the first crack in the façade will be devaluations. 

Creating economic growth at the zero boundary of rates is a zero sum game because the only source of relative value is a race to the bottom of currency valuations. History shows that choice wins local elections in the short term but starts world wars in the long run. This is why only a massively expansionary fiscal policy can save us now; the monetary policy choices of central banks are simply out of options and out of time.

Removing uncertainty will be the single greatest driver of legitimate economic growth and this is the only remaining tool left to avoid several years of a deepening global recession. This means taking the possibility of pension reform and social security theft off the table from those have earned those benefits. It means a dramatic expansion of early health, education, and nutrition programs for children and young adults.  It means paid maternity leave in line with the rest of the developed world, equal pay for equal work, and more than anything, removing the bullets from the chamber aimed at the poorest among us.

Yes, all of this costs money. But the choice is ours: Own a better future funded by long duration obligations at the lowest rates we will see in our lifetime, or kick in the walls of a house of cards that we built.

The core values of inclusion—the only ones that can drive economic growth—can only be funded by an expansion of the federal government’s balance sheet in order to have the capital that will create opportunities the extraordinary pent up demand want to invest in. Low rates are not a driver of growth, but a symptom of panic. We need policies aimed at removing uncertainty among the poorest of citizens while simultaneous offering returns to the richest, rooted in legitimate growth and not mythical asset appreciation driven by astronomical private equity valuation or stock buy backs. 

A Republican presidency, and the associated slash and burn fiscal scorched earth policy, will crucify any hope of economic growth for this generation because expansionary fiscal policy, not creative monetary policy, is our last, and only, hope. This crucial choice will not go unnoticed by the rest of the world and the alternative will truly make 2008 seem like a warmup.

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