No more middle of the road, left or right

Imagine there is a run on cash because the value of the paper stuff, bonds, shares, mortgages and their derivatives, seems increasingly uncertain. The variety of banks, insurers and funds that hold most of this paper must sell it to supply the growing demand for cash. All this selling brings down the price of paper assets and, hence, the value of reserves held by banks, insurers and funds. This spiral could get nasty, but the central bank intervenes by buying all the paper on offer, thereby stopping the fall in prices and then pushing them up again. After a while things are back to normal, with asset prices higher than ever, until the next cash chase.

This briefly describes the events of 2008-2009, and after with quantitative easing. What is not mentioned is the destination of all that cash, and the possibility of central banks repeating the same scenario in the not too distant future. A large part of the new money created by central banks went back to paper assets as their values began to rise again. Central banks created money to buy paper, and those selling used the proceeds to buy paper. Each new monetary unit produced a demand of two units. Prices rose steadily to peaks last July, only surpassed in the last few days. Central banks saved global finance from catastrophe by inflating an even larger bubble. So that when the next run on cash sets in, central banks will have to create money at an even faster rate than they have these last ten years. This may have already begun, as the New York Federal Reserve has increased its operations on the repurchase agreements market (repo) from 35 to 45 to 75 and finally to 120 billion dollars per day. Meanwhile the US Federal Reserve is reducing short term interest rates and is resorting to QE all over again. All this signals a liquidity shortage that could worsen with Xmas shopping.

The world spends more than it earns, which means a lot of borrowing. This has been going on for ages, with debts piling on debts. It has been estimated that more than three years of income are owed worldwide (1), and this sum is multiplied by derivatives (2). The 2008 crisis was triggered by mass defaults on mortgages that had been packed up with other debts and sold on. So that no one knew where they were and which package was good or bad. Today’s defaulters are car-buyers, and the sums involved are small compared to house-buyers ten years ago. Governments have also considerably increased their debts. But governments cannot default, at least not on their home debt, whereas some have defaulted on their foreign debts. The other big borrowers have been corporations, allured by low interest rates. A lot of this corporate debt has been used to buy back shares, as financial “engineering” to push up dividends for the remaining shares. But it has also kept alive all those “unicorns” that spend more than they earn. All that government and corporate debt will never be repaid and will have to be renewed at term, in some near or not so distant future when lending conditions could be far less advantageous. At present, rates of interest on Treasury bonds are close to or below the rate of inflation. This is still better than holding cash, except that cash can be transferred abroad and lent at much higher interest rates.

Central banks have poured cash into the financial system to keep it functioning. This has produced an upward transfer of wealth to the very rich, but has not cured the illness. It is life-assistance to a moribund patient and seems to be able to continue indefinitely. A small minority is bloated with wealth, while the rest must work countless hours just to afford a roof and transportation. The eight-hour day, obtained by long and bitter struggles, is just a memory for many workers, while so many more around the world have never experienced it. Central banks are sustaining government budget deficits by buying up Treasury bonds and keeping interest rates low. Banks are then lending this cash to companies that are buying back shares to boost their market prices. But none of this is adding anything to the average household income. It just makes the rich richer, the not so rich poor and the poor even poorer, though a lot of that wealth is just paper and could be scrapped overnight. Such an impoverishment of the middle-class had not occurred for close on a century, since World War 1 and the ensuing upheavals. When the middle-class is déclassé, its members follow one of two paths. They may join the working class and share their knowhow and assurance, or they may follow a leader who promises to restore their former status. Some try one and then the other. When the middle-class realises it has no future, it can follow a revolutionary path or a reactionary one. It can be a servant to the poor or a slave to the rich. Those two possibilities will not stay open very much longer, as events accelerate in one direction or the other.

1. https://www.axios.com/global-debt-increase-q1-2019-92ef0a63-b86e-471d-84c8-588a719f3fc2.html

2. https://www.investopedia.com/ask/answers/052715/how-big-derivatives-market.asp