The Covid-19 pandemic caused economies around the world to plummet. Governments reacted by issuing stay-at-home orders that caused problems for many as their income and livelihoods were destroyed.
Governments spent money like crazy trying to help people weather the Covid storm, but they actually helped create problems with their lockdowns, with fear and panic causing the biggest decline in a hundred years.
Globally, we add more than 20% to our debt burden in approximately 18 months.
It’s not over yet either, and lawmakers have a new panic to worry about, and it could make Covid-19 look like a cold.
While economies are recovering thanks to high spending and ultra-low official interest rates, debt levels have skyrocketed. Never have so many central banks had negative real rates. Currently, 52 of the 59 large economies have negative real rates.
The message is clear. Your money is losing value in the bank, so spend.
The world debt-to-GDP ratio rose to a record 290% last year. It fell to 280% as the GDP of many countries recovered quickly, but 280% is much higher than the 240% before the pandemic.
Monetary policy normally combats inflation by raising interest rates, but only a few central banks have done so, most have not. Some authorities may have raised their rates, but interest rates are lower than inflation.
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Savers are encouraged to spend. In many countries, you can borrow money from the bank that is lower than inflation.
The inflation target is dead, as the average real policy rate has been more negative during the last decade than before 2010.
The supply of M2 money (cash and near-cash) of some 75 countries accelerated as governments, businesses and households spent.
Global inflation is now about 4.6%, the highest rate in 13 years. This is in addition to rising food prices, while the cost of heating oil and gas is also rising rapidly.
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The global supply chain is seriously disrupted.
Container rentals have increased tenfold. Commodity prices are generally on the rise.
The prices of assets like houses rise much faster than inflation.
By now, by normal policy guidelines such as Taylor’s rule, most countries should have raised official interest rates. Surely central banks should have raised rates if they still want to reduce inflation, since the typical forecast for inflation is that it is increasing.
Inflation expectations will also rise the higher inflation rises and the bad news from the droughts in Brazil will affect everything from orange juice to coffee.
The inflation spectacle could get a lot more unpleasant.
Remember, inflation takes money from workers’ wages.
Negative policy rates with high inflation are the worst destruction of savings known to man.
Germans are already buying gold, while others are pursuing equity strategies or buying cryptocurrencies in hopes of preserving wealth. Assets growing now are riskier as both stocks and bonds are at very high levels.
In my opinion, high inflation is now the accepted outcome of central bankers, as they choose to help reduce the debt-to-GDP ratio rather than savers who have come to rely on real rates and low inflation.
For companies in the real economy, planning for expansion is also about to become much more difficult as inflation rises. The old enemy seems ready to return.
World GDP growth for this year is forecast at 6%, while next year most forecasters see it at around 4.5%. After that, the forecasts are now 3% and lower.
At first, central bankers said that inflation is temporary and would quickly decline below targets again. Since then, they have changed the language to transitional inflation or “a period of mild inflation over the medium term.”
Inflation may decline a bit, but that is no longer assured.
Aiming for lower inflation is dead; was killed by the pandemic
This while the real median of the country has a policy rate that is now 2.5% below inflation. Higher growth and higher inflation, and we should be raising rates, but that’s not going to happen in a decade or maybe even two.
The inflation targeting policy is so deeply buried because of the debt mess the world is in.
Debt at 280% of world GDP tells us that debt service costs are now the most important factor for central bankers.
Individual debt exceeds $ 300 billion or around $ 39,000 (about R600,000) per living person.
That is well above the world nominal per capita income.
Data from some 31 countries show that the median debt service relative to GDP for the private sector alone is 15.4%. It is increasing even with very low interest rates. The average real policy rate is now 2.5% below inflation! If it increases, the world debt bubble will burst.
This is because if interest rates rise from these ultra-low levels to combat inflation, total private sector debt service relative to GDP will increase.
At 2.5% below inflation, central banks would normally raise rates to about 2% or more above inflation.
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According to my calculations, the cost of debt service as a percentage of GDP for the typical country would increase to around 25-30% of GDP.
Interest payments from the public sector also increase, which would also lead to a slow but sustained increase in the costs of servicing the public debt.
Suddenly, borrowers would have to double their payments, and that will cut expenses by as much as 20% as they pay the banks.
Banks will not find new customers, and with falling demand, GDP will shrink faster than debt. Houses and cars will not find buyers and the Middle East will be giving away oil.
Price deflation is very likely then, which will further reduce nominal GDP and the debt burden will be even more difficult to manage.
That is the dilemma the world is in now.
Central bankers need to know this, and therefore the silent agreement is “to talk about inflation so we can keep rates low.”
Let us pray to get out of the debt dilemma alive.
Welcome back to inflation
The only way to reduce the debt burden is to make inflation rise, as it helps increase global nominal GDP.
Let’s say 2% real growth occurs and inflation increases 4%, then nominal GDP increases 6%. I expect the debt level to only go up, say, 4%.
That would reduce the debt burden much faster than through 2% inflation alone. Of course, it also reduces debt service costs, which again helps consumers spend more and that helps growth.
So fill in inflation: we need inflation to help nominal GDP grow.
Official rates allow most countries to keep the cost of debt service low, and quantitative easing helps keep rates on government bonds low, and governments can take their time to pay off debt or contract a debt. new debt to pay off old debt with higher interest rates.
The fact that the large midsize economy has already experienced an increase in the percentage of GDP that debt service costs, despite the fact that the same economies have the lowest real policy rate, shows the dilemma.
If monetary policy rates rise, debt service costs will rise as a percentage of GDP for the private sector, including households and nonfinancial firms.
If inflation is high and interest rates are low, consumers would be crazy not to spend or at least not save in the bank. Inflation would eat up your savings, so why not spend it on something now?
Your debt we forgive you for sneaky inflation
Negative real rates are also, in effect, a form of debt forgiveness.
People with loans are paying less than they normally would, as in some countries prime rates are also below inflation, but lower rates destroy the value of savings, foreign exchange, etc.
And if everyone does this together, then all coins fall with inflation and no coins should fall out of bed. That’s the tricky part for central bankers, as it goes against their values.
So it makes sense to borrow to buy some assets, like the house you intend to stay in. In the current scenario, the value is likely to go up, and while your salary may not go up, the low real rates will make paying it affordable. If you’re sure of rental income that can help pay for the house, haggle here, too.
In some cases, in South Africa, people who bought houses after the great financial crisis are now paying less to the bank than they are paying for fees and taxes.
Since most central banks cannot afford to raise rates much, the risk falls entirely on the bank, as the prime rate at least is about to be overtaken by inflation.
Debt forgiveness is not that you do not return the money to the bank, but that in real terms, that is, adjusted for risks such as inflation and default, you pay less.
Practical example …
Think of it this way: If you buy a house and the rates are 1% but inflation (and house prices) are at 5%, you are effectively paying much less. With a loan of, say, 1 million rand, you pay back 1.22 million rand over 20 years, but the value of the property increases to 6.65 million rand.
Over 20 years, the owner gets the difference of R1.43 million, or twice the original value.
In effect, this is ‘stolen’ from the saver; the saver who did not borrow the original amount actually lost R1.43 million.
This is the rising “inflation for the debt reduction economy” from policy makers now. In fact, you may be drawn to borrow even more, and central banks will struggle to raise rates for much longer than they expected as the debt ratio will continue to rise.
That means that all real assets like houses, stocks, and commodities are the only real game in town.
I would be very afraid of my pension fund, which has to hold at least 25% in interest-paying assets. That part was giving reasonable returns, not now. (You might expect a commercial property boom, but unfortunately we left the office and the mall for delivery from the warehouse.)
Hold on to your donkey, it will be a wild ride.
(But he borrows the money to buy the donkey.)