Less than a decade after the biggest financial crisis since the Great Depression, over-zealous central bankers are risking a second economic collapse. The continuous credit creation and rock-bottom interest rates in the U.S., China, the EU, and Russia are meant to incentivize lending, but really they are engineering a second, much larger, financial crash.
Monetary stimulus provided the backbone for a global recovery by adding liquidity to the market and bolstering asset prices. The Federal Reserve’s quantitative easing program quadrupled the central bank’s liabilities from $1.0 trillion in 2007 to a whopping $4.0 trillion this year.
Other nations watched as the Fed printed cash to buy junk bonds from distressed banks—a move that won them a stock market boom. The strategy appeared so successful that lawmakers at the European Central Bank rushed to imitate it, with China and Russia following closely behind.
But the trouble comes in disentangling that support. Liberal use of the printing press became the sole antidote to stagnation, but at some point the economy needs to stand on its own two feet. Have we made that impossible? Will the economy collapse without free credit from central banks?
I’ll be honest; it doesn’t look good, folks. But let’s take a closer look.
A Second Financial Crash Coming Soon
It’s not just me who thinks central banks have backed themselves into a corner. Albert Edwards, a prominent analyst at Societe Generale, says, “I have not one scintilla of doubt that the western central banks have set us up for an even bigger version of the 2008 Great Financial Crisis.” (Source: CNBC, July 30, 2015.)
Edwards is right. But he mistakenly zeroes in on the Federal Reserve when the problem extends much further than that. Take the eurozone, for example.
The European Central Bank was late to the printing party, launching its QE program as recently as March 2015. The ECB stepped up its monthly bond buying from 13.0 billion euros to 60.0 billion euros ahead of Greece’s (umpteenth) sovereign debt crisis. Yes, that storm may have momentarily passed, but the underlying issues remain and Europe’s growth is still lackluster.
Meanwhile, Russia’s central bank continues to slash interest rates as the country’s recession deepens. Second-quarter gross domestic product (GDP) was 4.4% lower than a year before, and GDP forecasts are constantly revised downwards. The country simply cannot afford to ease up its aggressive monetary policy. (Source: Bloomberg, July 31, 2015.)
With China in the Mix, This Next Financial Crash Will be Huge
However, the biggest problem I see is China. Let’s not forget that China was heralded as the savior of global growth in the aftermath of the 2008 financial crash. China’s tightly controlled financial system saved its banks from the contagion of bad credit, allowing the country to expand more than nine percent in both 2008 and 2009.
China is the miracle economy; the supposed counterweight to American influence on the international stage. Yet the country’s central bank is borrowing directly from the Federal Reserve playbook: do anything and everything to prop up the stock market. They entrenched themselves by letting a credit-fueled bull market dictate their actions. When margin trading became legal in June 2014, the Shanghai Composite Index went up 150% in a year. Then they scaled back the margin trading and we saw a 30% drop-off.
After the stock market crashed, regulators forced state-owned enterprises to buy shares of endangered companies. These are de facto bailouts going on right now. And they’re being funded by newly created money.
Think about that; China is now signalling to markets that they will prevent a fall in stock prices, even though the bull market was funded on credit. All around the world, printing presses are being used, not just to prevent crises, but to manufacture growth.
Dear readers, it’s been seven years since the financial crisis and markets still cannot stand on their own two feet. The recovery has been an illusion, and when fundamentals eclipse investor optimism, another stock market crash will send the world tumbling headfirst into chaos.