I’ve said it before and I’ll say it again. Central banks are in such dire straits. ECB President Draghi admitted that he is merely doing what every other central bank is doing. Group think. Perhaps more telling is Alan Greenspan has started to put himself into the public again saying we are in trouble. You know we are in really big trouble because he’s always ‘behind the curve’. My bigger concern is how the Central Banks cannot play moral hazard like the private sector has. If central banks decide to magically make debt disappear through a debt jubilee the financial devastation would be 100x worse than 1929.
The Japanese have been toying with a plan to wipe out the US$10 trillion of public debt by converting the JGBs they’ll buy with printed money into zero coupon perpetual bonds.The value of a zero coupon perpetual is mathematically zero. So in a heart beat the Japanese government debt gets written down to zero. The Bank of Japan has a $10 trillion asset which is now worth nothing. 200% of GDP gone in an instant. Mauldin also made this assertion that monetising all debt at once by all countries would be unthinkable but the only way you could do it.
Let’s entertain the premise if Japan did this. What would happen? Global markets run on confidence. Nothing more. Nothing less. Without confidence markets will fret. People forget that the Japanese government STILL needs to fund Y40-50 trillion every year to plug the hole in the deficit. Tax take is less than Y56 trillion. Expenditures, thanks to an ageing society are rising above Y100tn. That gap won’t close easily. Sure the BoJ could print that gap every year but honestly, how could Japan’s yen be worth anything if they printed $400-500bn per annum? That’s right Japan would press start on the printing presses and produce the GDP of Thailand or Austria or Sweden or Belgium or Taiwan. Does this pass any sniff test?
Japan imports 60% of its food. It imports most of its energy sources like coal or LNG. It imports iron ore and coking coal to make steel. They must pay these foreigners in their currency. What supplier would want to accept a currency where the central bank just prints it. No country would accept yen pricing. Yes, hyper inflation would be the result.
The debt service costs of the Japanese banks would become extreme. The low interest fixed mortgages which drives bank income are funded by predominantly depositors. However to avoid the Japanese banks witnessing capital flight they would need to raise deposit rates to dizzying levels and even then as Mrs Watanabe realises the Japanese yen is becoming like the Zimbabwean dollar she’ll convert into another currency exacerbating the downward pressure. Japanese banks would quickly become insolvent. Then corporations would start collapsing causing widespread unemployment.
The Global Financial Crisis (GFC) of 2008 taught us about moral hazard. People just walked away from their interest only mortgages and left the taxpayer to clean up the mess. Moral hazard is not good under any circumstances but if central banks and governments start playing moral hazard by ‘walking away from debt’ then effectively you permanently ruin trust and financial markets are destroyed. Think about. If people think that the end game will always result in a bail out then moral hazard becomes the default. It is permanent helicopter money. There is absolutely zero incentive to act prudently. Everyone should have a $50mn home, a Rolls-Royce and not have to work for it. Simple economics means that this solution is completely untenable. In a sense paper money would be worthless, we would have full unemployment and society would cease to function.
Now before we start reeling off the resumes of the incredibly intelligent people who can mathematically prove theories like this, note that was exactly the same type of argument hurled at me back in 2001 when I heavily criticised Greenspan predicting he would lead the world off a cliff in 5 years. I was right and they were wrong. Central banks have no idea. Their policies are group think. They don’t live in markets. They don’t breath markets 24-7. The only thing Greenspan was right on was to say “The gut feel of the 55-year old trader is more important than the mathematical elegance of the 25-year old genius.” Ask any of your experienced financial sector friends and get them to give you their gut feeling in private (publically they’e always bullish) and their answer to an almost 100% degree will be funereal.
If Japan makes the move to make $10 trillion dollars disappear (i.e. the GDP of China, home to 1.2 billion people) it will be the biggest mass suicide the world has ever seen in financial markets. You can take that to the BANK.