FreeLunch

In response to the fiscal crisis and associated recession, central banks in the many advanced economies have embarked on a ultra easy monetary policy, with interest rates about as low as they can reasonably go, boosted with occasional bouts of quantitative easing.

In my opinion they’re doing two things with this ultra low real interest rate/QE combination. Firstly, they’re borrowing consumption from the future, in a phase when I think the market would rather recover some “payback” from previous borrowings already made against future consumption. Second, they’re probably trying to inflate away the accumulated real value of the debt overhang, at the expense of creditors like future pensions etc. 

But even by their own admission, central banks did not intend the easy monetary conditions to be the solution to the problem. They only ever intended to buy time. What was meant to happen meanwhile is that leadership in the advanced economies would trim the fat off their bloated budgets and get the workforce more cost efficient. By cost efficient, I don’t mean the advanced economies are all unproductive, I mean their standard of living to production ratio appears far higher than China/India etc. That’s the core thing, that the world is finite. Much of the economic growth which emerging markets are enjoying is at the expense of the advanced economies, and this will continue until advanced economies can produce goods almost as cheaply. Outsourced production is the clearest example of this.

So, in simple english, the average worker in the advanced economy earns too much relative to what he can produce, when compared to the emerging markets. Much of that wage is then spent on goods manufactured by the emerging markets. Its clearly unsustainable, but ultra easy monetary policy props it up, preventing the inevitable rebalancing by facilitating the status quo.

This global rebalancing of quality of life, tending lower in advanced economies, higher in emerging, is going to happen anyway. The longer its postponed, the worse things get for advanced economies. I fear the rebalancing may occur suddenly in a collapse, if they leave it too long. But the changes, however necessary, have been glacially slow in coming. Hence, central banks are forced to try to buy yet more time, in the possibly vain hope that politicians would find the grit this time, to do exactly what they failed to do last time. In my opinion, they have a better chance of getting a supermodel to own up to a fart in an elevator. Still, you never know, one or two countries might accidentally vote for a leader who has the guts to choose between the unpalatable and the disastrous.

Meanwhile, advanced economies (and some emerging) are probably stuck with ultra easy monetary policy, for a lot longer. What about inflation? As suggested above, it is my belief that high inflation would not unduly offend the leadership of the advanced economies, if accompanied by some economic growth. So advanced economies can expect negative real interest rates for some time.

That pushes SA into a corner. I expect our Reserve Bank to follow suit, keeping rates low longer than they would otherwise prefer. Unless our inflation skyrockets, they sort of have to. SA doesn’t call the tune when it comes to world interest rates, but we do dance to it. Meanwhile, economic reality is surreptitiously pulling away one of the chairs.