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Will 2016 be the year of “the bigger fool than me”?

Could 2016 be the year when the unsustainable global asset and debt bubble finally goes public?  If the years following the Global Financial Meltdown of 2008 are true to form, we may well be about to enter the “public” or “bigger fool than me” stage in the economic cycle.

Geographer and economist Jean-Paul Rodrigue set out the four phases of the cycle:

The phases of a bubble

Coming out of the previous recession, the early (and more reckless) speculators seek a better than average return on investment.  Those that are successful – the so-called “smart money” – then come to the attention of the (more conservative) financial institutions, which begin to buy-out the smart money investors.  Institutional investment drives prices even higher, and leads to further institutional investment until the system runs out of new institutional investors.  At this point, market prices falter.

Up to this point, the general public has only been indirectly involved through pensions and insurance policies managed by the financial institutions.  However, the only way that the institutions can maintain rising prices is to open the market up to the wider public directly.  This is relatively easy to do, since the apparent returns on asset speculation tend to be significantly greater than those offered by high street savings accounts.  So the financial institutions create public investment vehicles for direct sale to savers, which they use their considerable PR muscle to promote via the mainstream media.  Anyone who remembers the years immediately prior to 2008 will remember how the financial pages and mainstream radio and TV programs acted as little more than pimps for the financial industry; promoting dodgy investments at unrealistically high rates of interest with institutions that ultimately had to be bailed out by the taxpayer.

To understand where we are in this story, you first need to understand how money is created in the modern economy.  A recent Bank of England paper explained it this way:

“In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”

So when central banks pumped vast sums into the banking and financial sector after 2008, the intention was not simply to bail out banks and provide massive bonuses for senior staff, but to encourage a new round of lending which, with interest rates close to zero, was meant to create the new money needed to stimulate renewed economic growth.

It did not work out like that of course.  With interest rates at close to zero, banks and financial corporations were able to avoid public lending altogether.  Instead, they chose to borrow money directly at zero percent in order to inflate several asset bubbles in share buy-backs (where companies buy back their own stock in order to artificially inflate the apparent value of the company); property (particularly in the UK and especially London); fine art; and, in the USA, auto loans, student debt and the soon to burst fracking boom.

Meanwhile, demand has been slaughtered in the real economy.  Rigged unemployment figures (which only count people currently claiming a benefit) vastly underestimate the number of adults in the developed OECD countries who are either without work entirely, or who need additional work to keep themselves above the poverty line.  The impact of this is seen most obviously in the manufacturing regions of the global economy, and most notably in China.  The impact of falling demand has created an investment overshoot as China’s “growth on steroids” runs into the brick wall of collapsing demand for its products.  Factories, property developments and even entire cities that were built at the height of the “Chinese economic miracle” will never be used.  What plant the Chinese did bring on line is now forced to sell its produce cheap onto world markets in order to maintain market share just to keep servicing the interest on capital investment.  But production is being scaled back – causing huge falls in commodity prices that impact severely on raw-material rich developing countries that had borrowed (in dollars at foolishly cheap rates of interest) to fund the additional capacity required by the Chinese.  The end result – although nobody wants to talk about it just yet – is that many of these countries are going to default on their loans, turning financial investment vehicles (like your pension and life insurance) in the developed countries into worthless paper.

In the developed countries we witness the impacts of this process in what remains of our own manufacturing base.  Mines and steelworks have been forced to close, and even advanced engineering companies like Rolls Royce have been obliged to “restructure”.  In the USA, General Motors, kindly kept afloat with bailouts from US taxpayers, have chosen to return the favour by moving manufacturing to China (which now has plenty of spare capacity).

So why has demand collapsed in the developed countries?

The main reason is that the collective credit card is already maxed-out.  The level of private debt to GDP in the developed countries in 2008 was at a historical high point.  And the collapse scared people – who faced losing their homes and their possessions and being forced to fall back on increasingly punitive social security systems.  It was always a big ask to try to get people to take on more debt.

Today, the ratio of private debt to GDP is close to the highs of 2008.  In the UK this has been largely driven by mortgage borrowing underwritten by various government schemes like “help-to-buy”.  In the USA, student loans and auto loans have also been used to bump up lending and thereby add new money into the economy.

But it was never enough.  The fundamental flaw within our current system is that almost all (97%) of the money in existence was created with interest attached.  This is why the system has been referred to as a giant Ponzi scheme in which exponentially more borrowing must occur at each stage in order to pay back both the “principal” and the “interest” on the money that already exists.  And the sad truth is that we have already borrowed more money into existence than can ever be borrowed in future.  In effect, we have reached “peak debt”.

Graph showing UK private debt

So what comes next?

Analysts have often compared the economy to one of those cartoon characters that is able to run off the edge of a cliff and keep going unless or until he looks down… after which he plunges down to rock bottom, leaving a smoking crater on the floor.  That is, while the smart money can see where the economy is headed, everyone involved maintains the illusion of business as usual until business as usual is no longer possible.  In the meantime – and behind the scenes – the key players conspire to ensure that someone else gets to take the hit when the system comes tumbling down.

What happens at this point is that – as happened in the years running up to the stock market crash of 1987, the dotcom bust of 2000 and the banking collapse of 2008 – the system goes public.  Since 2008, savers have struggled to get a return on investment greater than inflation.  The best savings accounts on offer serve merely to maintain the value of the investment, but provide no real return.  Property has offered the phantom of a return, but this is only really the case if the property can be sold – and only one seller gets to sell at the top of the market.  Once prices crash, investors are stuck with property that is worth less than they bought it for.

So the banking and financial sector understand full well that there is a sizeable group of chumps… sorry, “investors” out there who are desperate for an apparently safe above-inflation return.  And the bankers are about to offer them just that.  It is no accident that the UK government just scaled back all of the regulation put in place after the 2008 crash.  Nor that the banks have already begun to employ the new salespeople whose income will depend on fleecing the bank’s customers once more.  Nor is there any accident in the government’s decision to allow pensioners to invest their pension pots in any savings or investment vehicle rather than obliging them to take out an annuity.

In 2016, we are about to witness the repackaging of all of the dodgy debts and asset speculation conducted by the banks since 2008 (and much of the funny money still in the system since before the crash) into new – apparently safe (because the nice young man in the smart suit who works at the back says it is) – savings vehicles offering better than inflation returns on investment.  We can expect all of the bubble rhetoric to be trotted out once more.  “This time it is different”…  “The economy has reached a new plateau”… “We’ve learned the lessons of the past”… etc., etc.  We can expect the financial pages to begin pimping for the banks once more.  And, sadly, we can expect a large number of suckers to be parted from their money.

But the reality is that we have reached the “bigger fool than me” point in the economic cycle.  The point at which the banks desperately seek fools to eat the losses.  After which, the only direction is down.

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