How a debt-driven economy creates more frequent crises – Analysis – Eurasia Review
By Daniel Lacalle *
The pace of global recovery since 1975 has been slower and weaker, steadily every time, according to the Organization for Economic Co-operation and Development (OECD). Recoveries take longer and occur more slowly. At the same time, periods of crisis are less aggressive although more frequent than before 1975. Another interesting evidence of crises and recoveries since 1975 is that almost all economies end the period of recession with more debt than before.
Global debt has reached record levels, more than three times the world’s gross domestic product (GDP). For the economy to truly recover, we must stop the race for perverse incentives created by a poor analysis of the origin of crises and the solutions often offered in mainstream economics and politics. I agree with Johan Norberg that the two main factors that have led to the phenomenal progress that we have seen are free markets and openness. The freedom to innovate, experiment, create and share must come with the right incentives.
For decades, governments and central banks have always identified problems in the economy as demand problems, even if they did not. If there was a crisis or recession, governments immediately believed it must be due to a lack of demand, and subsequently decided that the private sector was unwilling or unable to meet the real needs of demand from the economy, even though there was no real evidence that businesses or citizens were investing or consuming less than they needed. The whole premise was that companies were not investing “enough”. In relation to what and decided by whom? Obviously by central planners who take advantage of bubbles and overcapacity but never suffer the consequences.
Governments and central banks never perceive the risks of excess supply, let alone predict a bubble. Why? Because most central planners see debt, oversupply and bubbles as small collateral damage to a bigger good: recovering growth at all costs.
Behind the diagnostic error hides the obsession to maintain or increase the GDP at all costs regardless of the quality of its components. GDP is relatively easy to inflate. I always explain to my students that GDP is the only economic calculation where you add what you spend with what you earn. GDP can be inflated by public spending and by higher spending fueled by debt. Debt is not a problem when it serves its purpose, which is to finance productive investments and allow the economy to grow, while efficiency, innovation and technology allow us to be more more and better goods and services at lower prices. It is a virtuous circle.
The virtuous cycle of credit turns into a vicious cycle of unproductive debt when we encourage bad investment and prevent technological substitution by implementing massive government stimuli and cash injections.
Central banks justify their actions by saying that they are not lowering rates, it is a market and the rate cut reflects private sector demand. Is that so? How and when did they probe this? Which private sector? Friendly or obsolete companies? The highly indebted? Also, if low rates and cash injections are a market demand, why not let the market fix rates and liquidity instead of central banks?
Those same governments that feel the need to “increase inflation”, which no consumer has ever demanded anywhere, do so because they benefit as the primary recipients of newly created money and money. the only sector that really benefits from inflation. Even the crony sectors do not take full advantage of inflation, the tax of the poor. These incur higher import costs and expenses.
By always making the same diagnosis, errors are repeated and accumulated. No wonder the pace of takeovers is slower, weaker and more indebted. Four reasons explain this weakness.
First, governments think the problem is lack of demand and present themselves as the solution, using savers to finance it, through taxes and inflation. The best way to boost GDP? Massive white elephants, huge infrastructure projects that generate a short-term boost to GDP spending. Infrastructure is needed, of course, but the difference is when countries decide to use it as a subterfuge to disguise growth. Build anything at any cost. This leaves behind massive debt and a less vibrant, not stronger economy.
Second, demand-side policies perpetuate obsolete sectors to the detriment of savers, wages and productive sectors. Governments will always subsidize and support the inefficient to the detriment of the efficient, because their goal is to keep what they believe works and to keep jobs. This is not due to bad intentions or bad goals, it is simply to perpetuate the past they are living on.
Third, massive cash injections and low interest rates are exactly the equivalent of indirect subsidies to inefficient people. The first beneficiaries and the most beneficiaries of “unconventional monetary policies” will, by definition, be the most indebted and the least productive. This is why productivity growth and currency velocity stagnate during periods of government-led monetary and fiscal excess.
Fourth, the advantages of the short and long term credit cycle are shattered. Creative destruction is all but eliminated, bad investment is fostered by excessively low interest rates, and liquidity is absorbed into financial assets and unproductive sectors.
Inflation does not rise as much as central planners want because technology and efficiency are unstoppable even if they try, and because overcapacity is perpetuated by constant refinancing. Massive liquidity and low rates are causing zombie companies to soar. The percentage of companies that cannot pay interest charges with inflated operating profits despite ultra-low rates and so-called “growth stimulus” plans.
Other signs of trouble
For decades, demand side policies have shown diminishing but not fatal results, but now the world has repeated the same policies so many times that there is simply exhaustion. Rates are too low, liquidity is excessive, and there is no real fiscal space in governments that have all but exhausted their ability to extract wealth from savers.
The more governments tell us that we need to spend more and save less, the weaker the response of economic agents.
Governments and central banks create a crisis out of a moderate and utterly healthy slowdown by denying business cycles and, worse yet, by portraying themselves as the ones that will reverse them.
Promoting a debt-driven economy leads to more frequent crises, shorter business cycles and sharp recessions.
* About the author: Daniel Lacalle, PhD, economist and fund manager, is the author of the bestselling books Liberty or equality (2020),Escaping the central bank trap (2017), The energy world is flat (2015), and Life in the financial markets (2014). He is professor of global economics at IE Business School in Madrid.
Source: This article was published by the MISES Institute