Podcast

matthi/Shutterstock

Alasdair Macleod: All You Need To Know About Negative Interest Rates

The implications of the ECB's radical decision
Sunday, June 8, 2014, 10:14 PM

On Thursday, the European Central Bank (ECB) took the historically unprecedented step of lowering certain of its interest rates below 0%. In a report to our premium subscribers immediately following the announcement, Chris likened the move to the policy equivalent of dropping a neutron bomb.

In the days following, despite the ECB attempting to clarify its stance further, many questions still linger; most notably: What exactly will the implications of this negative interest rate (NIRP) policy be?

We've asked our European correspondent, Alasdair Macleod, to lay things out in black as white as much as is possible. In this detailed podcast with Chris, he explains exactly what steps the ECB is undertaking, what the most probable ramifications will be, and where the highest degrees of risk now lie: 

The reason we have got into this silly situation  is you have got a two-way pull. On the one hand, you have got the central banks saying we need to get this economy going; which basically means that banks have got to lend to non-financial corporations in the EU in order to get these economies going. This is the sort of standard central bank mantra.

But the banks on the other hand in Europe are horrendously over-geared. When you look at a large bank like Deutsche Bank, you see its balance sheet is something like 55 times geared. I mean, it is enormous. The European banks have on the whole not managed to repair their balance sheets since the Lehman crisis in the way in which U.S. banks have. This leaves the EU banking system fundamentally weak and vulnerable. The banks know it. They would rather hold sovereign debt guaranteed by the ECB. They would rather put money on deposit with the ECB in order to lessen the systemic risk. Because otherwise they will lend it out to their peers and through the interbank market. They are now being told: Look, we will charge you for the facility.

Again, what the ECB is trying to do is they are trying to encourage banks to lend to the non-financial sector.

Now, there is another aspect of this. That is that they are making money available under something called the Targeted Long-Term Refinancing Operations (TLTRO). Now, under this, a bank can borrow from the ECB the equivalent of a bank's loans to the non-financial sector, excluding mortgage lending, at 10 basis points above the ECB's base rate of 0.15%. In other words, if you are a bank, a Eurozone bank, you can borrow from the ECB at a 0.25% for four years until September, 2018. Now the initial sizes of this facility is 400 billion Euros, but there will be further charges available in September and December.

You can see that here we have the ECB on the one hand and the banks on the other. The banks in the system have got the problem that some of the biggies are horrendously over-geared. But unless the ECB can get the economy going, the whole thing is going to fall over. Don't worry about the gearing lads, we'll make the money available. Just go out and lend it!

You can see that this is a very serious development. Just to give you a sort of a little bit of a flavor for the problem from the ECB's point of view. Inflation in the European monetary union has fallen to roughly 0.5%. This is against the target of 2% (bear in mind that the next set of bank balance sheet stress tests assumes the most extreme adverse scenario is an inflation rate of 1% percent...)

So, we are already at 0.5%. From the ECB's point of view, they are looking at something which is terrifying them: that's deflation. If you get deflation, then sovereign debt ratios are likely to spiral yet higher despite any austerity packages that countries like Spain or Italy might bring in. To illustrate this point, I think I am right in saying that today the Italy, Holland, and the Portuguese economies actually contracted in the first quarter of 2014. France, which was a biggie had zero growth. Now, you can see that if you have got declining and sort of falling prices in this environment. How and if you look at prices relative to the mountain of debt that these countries how, you can see that suddenly all sorts of ratios start looking very nasty. It is that, I think that the ECB is absolutely desperate to stop.

The reason they have announced NIRP the way they have is they want to drive the Euro lower. I think they feel that if they can have a lower Euro, then that will stop prices falling and indeed hopefully perk them up a little bit. But this whole idea is killing savings. I mean, central banks have been trying to do this ever since they have bought into the Keynesian theories. It has got us into a cycle of just worse and worse credit defaults. They are giving the medicine which historically has been proven to kill us. They are just doubling the doses.

This is not going to succeed, I fear. I'm not sure that the very short-term benefits that you sometimes see when they ease a currency are likely to follow through, because the whole point about driving a currency lower is that you persuade people against all reason that things are looking better. Businesses will employ people because they see that their margins are improving. They can start selling things again. That is the sort of basically the Keynesian mean.

At this point, I think this has been tried so many times that industry in the Eurozone and indeed elsewhere is no longer persuaded by this argument. I think everybody is now sitting on their hands and saying well, we actually do not really want to do very much. Because we just see risk, risk, risk. I don't think that the ECB can actually get around that fundamental problem with these latest measures. Everybody still sees risk. It may drive the Euro lower which may rescue the inflation rate from falling below 0.5%, but I really don't see that it is going to be more effective than that.

You see, Mario Draghi (the head of the ECB) is dealing with is a post Keynesian-world where our problem of Too Much Debt cannot be admitted. His objective as an appointed head of a central bank is to keep the show on the road at all costs; that's really what we are talking about. The level of debt and the amount of mal-investment in the whole system is immense. At the same time, they're killing all of the savers.

Here again, instead of doing what is the sensible thing to do -- that is, for us to save rather than spend -- they are doing the reverse. That they are effectively eliminating savings from the system and replacing it with newly-printed fiat money and bank credit. That's the attempt, and I have to say that I think it's bound to fail.

The ECB now finds itself on the cusp of this failure. Remember, there are some very big banks with gearing over 40-50 times. All you need is a fall in prices of 1%, 2%, or 3% for a few companies to go bust, and then those banks are no longer solvent. It is a nightmare scenario. It really is.

Click the play button below to listen to Chris' interview with Alasdair (55m:48s):

Transcript: 

Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson. Today we are going to discuss what I described as the "neutron bomb" dropped in Europe, which belied the fact that we are apparently in recovery. We have this idea that there is economic recovery. Inflation is a bit too low. But otherwise, things look peachy keen. You have got sovereign bond yields in Italy and Spain plumbing historic all time lows.

The bonds yields in Ireland actually on the ten-year, now at the same rate as those in the U.S. Apparently, everything looks fine. Yet, we find that the ECB did something quite extraordinary. In fact "extraordinary" is too soft a term. It is unprecedented. We now have negative interest rates for those banks, member banks, that are keeping their reserves and excess reserves, as we might call them, at the ECB.

That is one thing that we saw. As well, there were now, I believe—what else did they put up? Maybe they were going to allow for more open ended purchases of government bonds, maybe. They are going to make more long-term loans to banks. They are going to accelerate plans to purchase some asset backed securities and other stimulus measures. Well to help us parse through this and understand it, our favorite European correspondent, Alasdair McLeod. Alasdair, it is so good to have you again.

Alasdair Macleod: Thank you very much, Chris, nice to be with you.

Chris Martenson: Yeah. Well, you have just come off holiday, you are all rested, and the next thing you know we got what I am describing as a bomb shell. How do you see this move by the ECB? Is this just another reasonable step that a prudent bank might take because they are taking a cautious, if prudent, approach to how things are going? Or, does it signal perhaps maybe they are a bit worried about something?

Alasdair Macleod: I am afraid it is the latter, in my opinion. In fact, I think it is so terrifying, I think I would rather wish I was back on holiday. No, but seriously, this has been telegraphed for some time.

Chris Martenson: Yeah.

Alasdair Macleod: I think that the ECB knew that this would be too much of a bombshell to surprise the markets with. You have got, if you would like, a bit of a conflict. In fact, you have got several conflicts going on. The ECB has been primarily responsible for keeping the bond yields of the countries which are in trouble extremely low. They have been in the market basically buying those bonds.

Now, so far, when they have bought those bonds, they have shifted other bonds out from their balance sheet to make way from them so that the bond purchases were sterilized. They have stopped sterilizing those bond purchases. In effect, we already have the beginnings of QE from the ECB. As they stated, that this is—I mean, they are great for initials, these people. I hate it because you get these initials. Then you forget what they are. You think, my God, I have got to look it up again.

But anyway, there is something called a Securities Market Program. That is where they buy sovereign debt from issuing governments rather against their mandate, I have to say. But they neutralize it by selling other bonds. Now that sterilization is ending. We have now got in effect naked QE. How much, I do not know. Because they have got to manage their balance sheet remember. That is quite a problem.

Chris Martenson: The sterilization is you buy one and you sell one. You buy a sovereign –

Alasdair Macleod: Exactly.

Chris Martenson: – Bond of some kind. But you sell something else that you have in your portfolio. What they are really doing is picking—they want these bond yields to go down, but maybe they are willing to let these other ones go up. Was it that form of sterilization?

Alasdair Macleod: Well, in effect, no. Really, it has not been I think so much trying to manage these rates. But what they have tried to do, if you like, is give the market the confidence –

Chris Martenson: Yeah.

Alasdair Macleod: – In say the Portuguese bond market and the Spanish bond market so that others could come in and buy the sovereign debt. Because remember, under the Basel III agreement, sovereign debt takes no haircut. Now that is fine as long as you are happy that your capital is protected. In effect, the ECB has said to the banking system, we will ensure "whatever it takes." It was the actual phrase by, a bit over a year ago. Whatever it takes, we will ensure that the Eurozone sticks together and that none of these countries are going to fall over.

That was the implication. As a result, by going into the market and steering the market, buying a bit here and buying a bit there, they have been able to encourage banks—not only European banks, but banks from elsewhere in the world—to invest their euro holdings in sovereign debt. Of course, I mean, if you buy German debt, I cannot remember—I think ten years is about 1.4 percent or something like that. Instead what you do is you maybe look at Spanish or Italian debt knowing that the ECB is in there guaranteeing an inverted commerce, your position.

That is one thing we have been doing. But the other side of it, of course, because they are not allowed to do QE, the other side of it is they have had to sell some bonds to make way for it. Now, the overall effect, which they have managed very effectively, is to keep yields effectively down. Now we have a situation where they are not going to sell any bonds to buy more sovereign debt. You can see that we have now got, in effect, an open ended QE. It is not state how much it is. That will depend on how the balance sheet develops. Because they have got an asset side and a liability side on their own balance sheet to manipulate or to handle.

That is, I think, the important point about QE. I think the reason we have got into this silly situation, Chris, is you have got a two-way pull. On the one hand, you have got the central banks saying we need to get this economy going; which basically means that banks have got to lend to nonfinancial corporations in the EU in order to get these economies going. This is the sort of standard central bank mantra. But the banks, on the other hand in Europe, are horrendously over geared. I mean, when you look at a large bank like Deutsche Bank, you see its balance sheet is something like 55 times geared. I mean, it is enormous.

The European banks have, on the whole, not managed to repair their balance sheets since the Lehman crisis in the way in which U.S. banks have. This leaves the EU banking system fundamentally weak and vulnerable. And the banks know it. They would rather hold sovereign debt guaranteed by the ECB. They would rather put money on deposit with the ECB in order to lessen the systemic risk. Because otherwise they will lend it out to their peers and through the interbank market. And they are now being told, "look, we will charge you for the facility."

Again, what they are trying to do is they are trying to encourage banks to lend to the nonfinancial sector. Now, there is another aspect of this. That is that they are making money available under something called the Targeted Long-Term Refinancing Operations; which you will see in initials is TLTRO. Now, under this, a bank can borrow from the ECB the equivalent of 7% of a bank's loans to the nonfinancial sector, excluding mortgage lending, at ten basis points above the ECB's base rate of 0.15%.

In other words, if you are a bank, a Eurozone bank, you can borrow from the ECB at a quarter of a percent for four years until September, 2018. Now the initial size of this facility is 400 billion euros. But there will be further tranches available in September and December. You can see that here we have the ECB on the one hand; they have got the problem—the banks in the system have got the problem that some of the biggies are horrendously over geared. But unless they get the economy going, the whole thing is going to fall over. So… "Do not worry about the gearing lads, we will make the money available. Just go out and lend it."

You can see that this is a very serious development. Just to give you a sort of a little bit of a flavor for the problem from the ECB's point of view. Inflation in the European monetary union has fallen to roughly half a percent. Now, this is against a target of two percent. Now, bear in mind that the next set of bank balance sheet stress tests assumes the most extreme adverse scenario is an inflation rate of one percent.

Chris Martenson: Yeah.

Alasdair Macleod: We are already at 0.5 percent. Now, the problem here is that from the ECB's point of view, they are looking at something which is terrifying them. That is deflation. If you get deflation then sovereign debt ratios are likely to spiral yet higher despite any austerity packages that countries like Spain or Italy might bring in. I hope that gives you a flavor for the background to the situation.

The other thing is that—I mean, they really are making money available for banks. There is another horrible acronym: the FRFA, which is the prolonged Fixed Rate Full Allotment. Banks under this program can continue to borrow as much as they want at a fixed low rate instead of bidding for funds available. Because usually what happens is the ECB would say "right, this week we are going to make fifty billion euros available for banks who want to bid for it." They will come in. they will bid. They will bid sort of half a percent, or one percent, whatever the figure is. They are making this available without limit at a quarter of a percent.

Chris Martenson: Well Alasdair…

Alasdair Macleod: You can see the whole thing… Sorry, go on.

Chris Martenson: Whether it is a TLTRO, or an FRFA, or EIEIO [Laughs].

Alasdair Macleod: SMP.

Chris Martenson: Or whatever it happens to be.

Alasdair Macleod: Exactly.

Chris Martenson: The problem here is not liquidity, right? I mean, banks have access to massive amounts of capital, if they want. In fact, that is one of the things that the negative interest rate, which is on the deposit facility at the ECB is meant to shoo those funds back out the door. Like, "go, go do stuff with them." But really, is not the ECB just really looking at just one side of this? They are kind of saying, "hey banks, go out and lend." But as far as I am aware, there are two parties in a borrowing lending transaction. That is the borrowers.

It feels to me like there is, if not a borrower's strike, just a dearth of ideas to really need to borrow for. Certainly larger corporations who have access to both equity and debt markets, they do not need to borrow money from banks. They can do it through other mechanisms. Is this really a situation where there is just not enough incentive for banks to lend and if we increase the incentives, they will find loans to make? Or, is it that there is a dearth of borrowers, or where are we in this story?

Alasdair Macleod: I think it is a polarization. I mean, over successive credit cycles, what has happened is that companies that have access to securities markets, bond markets, or, alternatively, are cash rich, are the sort of people that these people would like to lend to. But they do not need the money. You have got a situation now where the companies which do need the money are basically in trouble without the money. Now that from a banking proposition is not a good idea.

The banks themselves are actually very frightened of the situation they find themselves in. Of course, they have responsibility usually to shareholders. In some cases it is very often to an individual government. But you can see that—I mean, I think the position of a director of a bank is very difficult. Because on the one hand he is being told by his government, he is also being told by the ECB, "you have got to lend money to bust institutions."

As a director of a bank, that completely goes against my ethics. I would sort of think that if I am being told this by the ECB, then the last thing in the world I should do is lend money to these people. I mean, I think the point is that we have yet to see whether these extreme measures will actually work. I do not know if that helps?

Chris Martenson: Well, it is a bit of an experiment, right? Let us back up then. Probably four or five months ago, we got our first hints that this was coming. This means that whatever the ECB has been looking at has been in play for a long time. On the surface, the thing that they talked in the public about is this idea that half a percent inflation is just a dangerous situation. Let us start there because I do think that needs to be explained and unpacked a little bit. Is the fact that my flat screen TV costs a little less this year than last year—how is that harmful to a bank?

Alasdair Macleod: Well, I would—I sympathize with your analysis, but we need to look at it from the ECB's point of view. Remember that the ECB is stuffed full of Keynesians and monetarists. The number one belief that they have is: deflation is death. On that basis, they do not examine whether actually something is priced correctly or incorrectly. But what they see, if you like—if you put it in terms of which you and I would maybe discuss it, they are concerned that there is an increasing preference for money over goods. When that happens, it drives the price of goods down. They are worried that they are essentially on a tipping point where that could well have happened.

To illustrate this point, I think I am right in saying that today the—Italy, Holland, and the Portuguese economies actually contracted in the first quarter of 2014. France, which was a biggie, had zero growth. Now, you can see that if you have got declining and sort of falling prices in this environment, how and if you look at prices relative to the mountain of debt that these countries owe, you can see that suddenly all sorts of ratios start looking very nasty. It is that, I think that the ECB is absolutely desperate to stop.

Chris Martenson: Well, let us spell this out there. If prices are falling what we are really saying is that they are worried about a preference demand where people are going to prefer to hold money and they are just going to wait for prices to continue to fall. But does that really hold water historically when you look at things? First of all, people's discretionary income might fall under that a little bit. But let us look at nondiscretionary items. If you need to put gas in your car or petrol in your auto to get from Point A to Point B to get to work; you are probably a little bit price insensitive to that. Food, you are going to buy no matter what. Your housing is probably a fixed expense. There are a variety of fixed expenses that to me seem completely immune to this process. Are they really worried that people are going to save more than they spend?

If that is part one of the question then part two is: is that such a bad thing after we went through this horrendous period of really advancing our debt loads to—across the entire OECD—the total debt loads of the nations now average 350 percent debt to GDP. First, does falling prices really inhibit spending? Second of all, is there no sense that maybe levels of debt are already plenty sufficient and we do not need to encourage them to go higher?

Alasdair Macleod: Your question goes to the heart, if you like, of the difference between the approach before Keynes came on the scene, when everybody reckoned that Say's Law or the law of the markets made sense, and post Keynes. Let me put it another way. I think you and I would be supporters of Say's Law. Now, that being the case, I think I might say that you and I would say the best way to sort this out is to allow a price adjustment to the level where people actually buy what they want because they can afford it. That way you would get an economy that would adjust itself automatically.

This process would actually be over quite quickly—probably in a matter of 18 months to two years. Companies would go bust because they could not adjust, they have got too much debt, or whatever. Certainly there would be problems with that. But if we did that, the situation would be resolved.

What Draghi is dealing with is a post Keynesian world where that cannot be admitted. His objective, quite clearly—and he is appointed to be head of a bank, a central bank, with a view to keep the show on the road at all costs. That is really what we are talking about. The level of debt and the amount of malinvestment in the whole system is immense. At the same time, they are killing all of the savings.

Here again, instead of doing what is the sensible thing to do—that is for us to save rather than spend, and those savings to be taken by industry and invested in new products to tempt us out of our savings. Or, to tempt us to spend with them. Instead of that, they are doing the reverse. That they are effectively eliminating savings from the system and replacing it with newly printed fiat money and bank credit. That is the attempt. I am bound to say that I think this is bound to fail. It is a real problem.

I think what the ECB now—where it now finds itself, is it finds itself on the cusp of this failure. Remember that if you have got banks with gearing—I mean, some very big banks with gearing have over 40, 50 times—all you need is a fall in prices of one, two, three percent or something like that, a few companies to go bust, and then those banks are no longer solvent. It is a nightmare scenario, Chris. It really is.

Chris Martenson: Alright, so the elimination of savings, creating new bank credit, the idea that these banks are geared 40, 50 times—let us go over into one part of this story and say the ECB is successful. They get what they want. Presumably what they want is they want banks to go out and start lending again like crazy. They would like to see credit growth really take off. People presumably then at that point are really engaging in a lot of economic activity. They see a lot of economic growth. Is that the plan? Are there any flaws in that plan?

Alasdair Macleod: You have summed up the plan, and the answer is: plenty of flaws. I think part of this is… The reason they have announced this the way they have is they want to drive the euro lower. I think they feel that if they can have a lower euro, then that will stop prices falling and indeed hopefully perk them up a little bit. But this whole idea of killing savings—I mean, they have been trying to do this. I say "they"—central banks have been trying to do this ever since they have bought into the Keynesian theories and it has got us into a cycle of just worse and worse credit defaults.

They are doing exactly the same thing. I mean, they are giving the medicine which historically has been proven to kill us. They are just doubling the doses. This is not going to succeed, I fear. I am not sure that the very short-term benefits that you sometimes see when they ease a currency are likely to follow through. Because the whole point about driving a currency lower is that you persuade people against all reason that things are looking better. Businesses will sort of employ people because they see that their margins are improving. They can start selling things again. That is the sort of—basically the Keynesian meme.

That, I think, has been tried so many times that industry in the Eurozone, and indeed elsewhere, is no longer persuaded by this argument. I think everybody is now sitting on their hands and saying "well, we actually do not really want to do very much. Because we just see risk, risk, risk." I do not think that the ECB on these measures can actually get around that fundamental problem. Everybody still sees risk. It may drive the euro lower, which may rescue the inflation rate from falling below 0.5 percent, but I really do not see that it is going to be more effective than that.

Chris Martenson: I would like to really jump in on that because there is an extraordinary misdiagnosis going on with this. The inflation that the Eurozone really needsand by "needs," I have air quotes up by this point in time—by which I mean, so that the banking system can continue to not collapse. That sort of inflation is growth in credit. When you have growth in credit and people are really borrowing a lot what you tend to see sometimes associated with that is rising prices for things, right? Because you have got good old monetary inflation going along.

But to the extent that they are just looking at prices and saying "that is what we are after. We would love to see two percent rise in prices." And the extent to which you do that by trashing your currency so that your imported food and fuel costs more and your basic raw goods cost more, that is not the same thing as inflation. It is rising prices, but that is just because your currency is falling. That works beneficially for a country if, and only if, you have a positive trade balance.

Let me spell that out. If you have a negative trade balance—that is, you are importing more than you are exporting—rising prices just kill you. Right? Japan is starting to experience this at this point in time. Those hurt. I could see Germany benefiting from a lower euro. I could see a number of other countries, but not all of them. Does, A: Do you agree with that analysis? And B: If you do, how does the euro experiment sell higher import inflation to everybody when it is not going to benefit everybody?

Alasdair Macleod: I agree with your analysis, absolutely. I mean, if you look at Germany and certainly—Germany, incidentally, is not happy with this at all. Sound-money people in Germany do not like this, and I think they are very worried. Remember the ECB is in the same town as the Bundesbank, so I should think that the politics at central bank level in Frankfurt must be very interesting. But you are right. Germany would benefit from a lower euro. The Mercedes, and the BMWs in this world would make even more money; which is fantastic.

I think that the benefits to Spain and Italy—I mean, what I am saying is I think they are hardly likely to be even temporary. Usually it would only be temporary because as you rightly point out, what happens is after a short period of time, you find that the rising prices of imported raw materials begin to catch up with you. Then you have workers who find that they cannot live on the salaries that they are getting, or the wages that they are getting, and they go on strike for more.

There is a risk they are going to trigger that series of events, if they are half successful. I do not think this will succeed. I think probably what will happen is that people will end up with wages with lower and lower purchasing power. I do not think that unemployment levels are going to fall so that people will find it difficult to strike. But what you might get, rather than say individual strikes, is you might get sort of more general social unrest as a result. I can see in a year or two's time riots initially in Spain and all of the rest of it as the inflation that you describe—rising prices from abroad—really starts squeezing people.

Chris Martenson: So what we are saying here is it is far from certain that this is going to work as intended. There is plenty of unintended consequences that could happen here, such as people striking for more wages, if they find that their import costs are really starting to eat them alive. Let us wander over to the ways this might not work.

The risk side of this: We had zero interest-rate policy, the so-called ZIRP, has now been replaced with NIRP, the negative interest-rate policy. Let us talk about what happens with NIRP. One of the things that I see is it is very likely that whatever meager rates of interest people were getting on their saved deposits are likely to go lower. First: Would you agree with that? Second: Is there a chance that banks might actually start transmitting this negative interest rate policy to savers themselves?

Alasdair Macleod: No, I do agree with you. I do not think that they will transmit the zero interest rates to savers. Or, I do not think even current account holders. It is not the same, if you would like, as the bank actually putting money on deposit at the central bank. But I think what will happen is that if you save money, basically you get zero interest. It is no good for savers. They are on a dead loss right from the start. I mean, even that sort of mild deflation under their definition with inflation falling to around about half a percent, they are losing year-on-year on year. Well, this is not good.

The only savers who make money are those who are prepared to speculate in bond and stock markets. Of course, those assets have risen recently. But I think it is an absolute disaster that they are destroying savings. I mean, this is not how Germany built her might in the wake of the Second World War. She built her might on savings. You have the famed Mittelstand, that sort of medium-sized companies who grew their businesses through a long period of monetary stability, of sound money policies.

The ECB is trying to destroy the currency as a means of advancing the overall Eurozone economic performance. It is in that sense a con trick. I do not think people will fall for it any more. You are getting less and less of a result from printing money than you might have expected, let us say on the last cycle.

Chris Martenson: Less and less, I would say we are getting less and less. But one of the things that you do get with printed money guaranteed is they are basically picking winners and losers. Savers got picked as the losers in this story. In the United States, I have seen numbers anywhere from 800 billion to 1.2 trillion—let us just call it a trillion dollars of interest that has not been earned on savings since the beginning of the crisis by savers. They did not get that trillion. But somebody else did. Those people tended to be the big banks and the liquidity centers.

What they have done is they have speculated with it—which was really the Fed's goal. It sounds like the ECB has the same goal, which is: "Let us make everybody uncomfortable holding stodgy old savings. Let us push them over here into this risk arena. Participate with us. We are all in this together. Let us all buy stocks and bonds and this will all work out." The thing that drives me a little bit crazy about this is that it confuses printed money with capital. It is treating all money as if money and capital—you can just combine those words, it is the same stuff, do not bother figuring out which word to use; they are interchangeable. They are not, right?

When you are talking about savings—so savings to me represent—you have a fixed, finite amount of money supply, or it is relatively stable. It is a sound money system. And it increases in proportion with the actual durable output of a nation of a people. Then savings have real importance. Then savings and capital are the same thing. You can accumulate that capital and it has its own beneficial way of sorting itself out through an economy.

But if we wander over into the big world of central planning—and I now think the United States, Japan, and Europe are all victims of the largest central planning effort ever. It just puts the Soviets to shame at their height. And now we have got this confusion, which I see in print all of the time. I see full blown economists using and saying things like, "with the capital that the Fed has created." Like, no no no. They have created printed money. That is one thing. Currency and printed currency then is—we can put as much of it out into the economy as we want, but what we will note is that the economy just does not seem to really respond.

This seems to me to be kind of at the heart of the—I do not really actually want to say "Keynesian" because I doubt Keynes would have been fooled by this. But the people who have taken his ideas and now morphed them into this idea that you can print capital. They are not getting what they expected. Their response seems to be to just do more of it.

The concern that I have is that, A: They are not learning from it so they have a flat learning curve on this. And, B: That all they are really doing is piling up massive amounts of claims against an economy that is not growing. They are not recognizing that. They are going to do more of the same; time to double down. When and how does this actually begin to end? What can we look for, Alasdair, that tells us that dawning recognition is coming to the center?

Alasdair Macleod: I think your analysis is interesting. I could sum it up by saying that the ECB's approach to this is: we are only interested in the banks and we do not give a damn about the small saver. Let us just go through the mechanism whereby this sort of action from the ECB is actually destructive of an economy. We have to understand that there is something called the Cantillon Effect. This is named after Richard Cantillon who is John Law's banker back in Mississippi bubble days. But this is the guy who was so smart, he got out before the whole thing fell over.

What he noticed—and he noticed silver in particular coming over from Mexico. He saw how it drove up prices in Spain first. And as that silver got circulated with further afield around Europe, then prices started rising elsewhere in Europe. This is known as the Cantillon Effect. The reason this matters today is that you have a central bank, which is the source of new money, if you would like, the equivalent of the silver that was being brought in from Mexico. What are they doing with it? They are giving it to the government. They are also giving it to the banks.

This is why bankers get lovely bonuses and all of the rest of it. They feel relatively rich. This is why people who are close to the financial system, and can game that system, walk away with a lot of money and buy huge houses in London and Monte Carlo and wherever. But guess what? The people who do not get this money are the small savers. They are pensioners. They are the people on low fixed income. The people who clean. These people who earn very little, they are the people who are being squeezed.

You can see that if you understand that relationship between the rich and the poor, what is actually happening is that the central bank is enriching the one or two percent, but impoverishing probably about 95 percent. There is a bit in the middle which sort of do all right. Like some people who actually own stocks who found that the stock market had gone up. Some people who own their homes in the right area. They found their house prices risen. You do get some sort of spreading of that effect. But by and large, you could probably say that it is an 80-20 rule. You have only got 20 percent at the very maximum who are getting any benefit out of this. Whereas the 80 percent are really suffering.

Now, if you are going to undermine the living standards of 80 percent of your population, you are not going to improve your economy. It actually is as simple as that. The policies that the ECB—in common with the other major central banks—are trying to impose upon the financial system is doing just that. It is killing the 80 percent. Maybe, not killing 20 percent, but only enriching less than five percent. So it is doomed to fail. The more they go down this route, the more it is doomed to fail. That I think is my analysis of it. When it is going to fail—which I think is sort of behind one of your questions: When are we going to see this falling over? I do not know.

I suspect that the signal will be the price of gold. I expect that—I mean, that is now so incredibly undervalued. If you think fine art has gone up—all of these inflation hedges like fine art, property, and stocks. They have been sitting on the gold price. I was writing a piece only this weekend for Gold Money. We have the Asian block, if you like, China and Russia, accumulating gold. All of those countries in Asia are accumulating gold.

We are talking about four billion people saying "thank you very much Western central banks for supplying us with our gold so cheaply. We are ditching it." Now, at some stage that is going to end. I think it is very close. I suspect that after the end quarter distortions, which we are seeing in the market at the moment—once those are out of the way, I think actually gold could run very fast and furiously. That, I think will be the signal that something has gone horribly wrong.

Chris Martenson: It is certainly one of the signals I am looking at. There was a very subtle point in there earlier that I really want to tease out. It is really important. And I realize I have to be more careful in the future, how I have talked about this. Because I have said before, you cannot print prosperity out of thin air. You cannot print purchasing power out of thin air. But it is not quite right. With the Cantillon Effect, I think the truth is you can print purchasing power. The problem is you cannot create real purchasing power. The banks print it up. The bankers get very real bonuses that allow them to buy very real things, whether it is fine art or trophy mansions in London, or even a thousand acres in the countryside, the printed money has real purchasing power. But it could not create real value. That purchasing power that was printed up, where did it come from? Well, it has to come from somewhere because if you cannot create something out of nothing then the mystery is to solve where it came from.

I think what is increasingly obvious to people is that it is coming from the 80 percent, right? It is coming from their reduced opportunities, their reduced standards of living, the increasing difficulty they find to make ends meet. It has to come from somewhere. The longer this printing effort continues, the summary I have is, the greater the inequities will grow and the injustice of it. It is the injustice that creates the flash points for us monkeys. That is the thing that gets people up out of their seats and into the streets.

Alasdair Macleod: Precisely, and if only Monsieur Piketty in his recent best selling novel—I called it a novel because it is not based on fact­—had actually understood this. Then my goodness, would not the world be a better place? If mainstream economists understood what you have just said, we would not be in this mess. But we are in this mess because they think that by trying to kid us about the value of money, that they can print some money and it is not going to affect the value of our savings. We would not have gone into this situation if they had not tried to kid us. I am sort of beginning, well, sort of thinking this through, the 80-20 rule. I think I am going to amend it probably to somewhere over 90 percent. Probably somewhere less than 10 percent.

Chris Martenson: Yeah.

Alasdair Macleod: Because it is a very serious point, and this is why it will never, ever work. I mean, if you think about the situation in the Weimar Republic—if they had measured Germany's GDP in those days, I mean, guess what? GDP would have been fantastic! But actually it is just a reflection of collapsing prices, and the difference between those prices being recorded and the transactions even taking place. Or to put it another way, the deflator when you have got an accelerating inflation is always insufficient to adjust the GDP number.

If you take that lesson, if you would like, or that example, and apply it to today, we know that the prices of goods and services are actually rising more rapidly than any deflator that is applied to GDP. If you accept that proposition, then we have been in a recession, or a slump—however you would like to describe it—since the Lehman crisis, with no let up. And that explains why things are so, just getting worse and worse. The central bankers have statistics which they are operating off, which are completely wrong and misleading them. I mean, it is—you could not make it up, really, Chris.

Chris Martenson: Well, is this a case—in 2008, we had the opportunity to just rip the band-aid off and let the bad companies go bust and let all of the dreck loans go into default, and then pick ourselves up and move on. I was an advocate for that, by the way. Because that actually lets the chips fall where they belong, in the hands of those who placed their bets wrongly. And I think that teaches important lessons.

But there is another side to that which is, "well, what they have done is they are really allowing us to peel the band-aid off slowly." But I actually do not see any peeling going on at all. I see structural imbalances. I see too big to fails even larger. I see the derivatives tower only larger. I see sovereign nations only further in debt. I see all of these key indicators just actually heading in the wrong direction. Do you think that this is just another version of—what we are seeing coming out of the ECB—is this just another can kick, a little more extend-and-pretend, but that ultimately all we are doing is actually building up the potential energy for whatever reckoning comes to a larger amount? Or, are they actually helping to diffuse this so that we can hopefully fall off of, you know, three rungs down the ladder instead of three rungs higher when the time comes?

Alasdair Macleod: I think it is extend-and-pretend. Extend and hope, keep your fingers crossed that something will work. I do not think it is more sophisticated than that. In any analysis, if you have a, if you like, going back to the difference between the laws of the market, Say's Law and the Keynesian approach—if you go with Say's Law, you would know this is going to fail. You understand why it is going to fail. The idea of stimulating one side of the economy is complete nonsense.

That is what they are trying to do. It is not going to work. It does not get rid of bad debts. It creates even more problems. The idea that this is sort of a band-aid, if you like, or a plaster on a wound, it is—I do not think that is a good analogy. Because what they are doing is they are making the wound worse and pretending that it is better.

I mean, it is an appalling situation. This is not going to help any economic recovery. If anything, over time, because of this transfer of wealth from the poor towards those sort of lucky bankers, and so on, and so forth, it is just going to make the situation worse. There is another aspect to this, which I would just like to touch on. That is that government is a big beneficiary of all of this printed money.

Chris Martenson: Of course.

Alasdair Macleod: What they do is they end up providing welfare to people who need it, as well as jobs for bureaucrats and all of the rest of it. But welfare that is actually provided into the economy has the effect of holding food and energy prices higher than they would otherwise be. It is not that the 80 or 90 percent are actually sort of finding that prices are not rising. Because the government is distributing money back into food and energy through people who, God bless them, need it. They are getting squeezed by the prices at the same time.

We are seeing this. I mean, obviously, it is a bit hidden by weather effects. I mean, before we came on air, we were talking about the drought in California. That does not help. The pork prices, I understand are getting very tight as well. Then there is the sort of Chinese situation. I do not analyze these things. But I can see that all of these sort of accidents suddenly seem to be happening about food prices and potentially about energy prices as well. The root of it basically is printed money and expanding bank credit.

Chris Martenson: Well, this gets us to the part of the story which just drives me absolutely insane, which is that the bankers, the central bankers, ECB, and the Fed—they seem be entirely unaware of the energy situation that we are in right now. In Europe it is completely mysterious to me. I am trawling the sites all of the time. I must be going to the wrong ones because I cannot find anybody talking at all about this rather dire situation that seems to be developing where our relations with Russia are not good.

Russia inks this extraordinary multi-decade deal with China to start supplying a huge amount of natural gas over to China. It is not clear that Russia can open the stopcocks and actually get that amount out of its particular reservoirs and to be able to send that off in addition to all of its current exports that happen to go to Europe in large measure. Then when you look at Europe's natural gas situation, a third is supplied by the Groningen field up there in Holland. That is going into decline at this stage. A third, a third of all gas on the European continent comes from one field which is in decline, and is about to really start to go into serious decline in the next ten years.

I am looking at the overall energy landscape. Then I look at the food landscape where you mentioned pork. I will take you to my favorite subspecies of pork, bacon. Bacon is up 53 percent.

Alasdair Macleod: Yes.

Chris Martenson: –Over the last four years; and ground beef is up 35 percent –

Alasdair Macleod: Is it really?

Chris Martenson: – Over the last four years. Oranges are up 35 percent, coffee 31; peanut butter is up 30 percent over the last four years. These are all statistics that were just released in April. We have got pretty extreme across-the-board food price hikes. Now we are going to see energy situations become even more dire. To me those are two great reasons to say, "Wow, we have got to make sure that our monetary policy is in accordance with these other realities." Complete divorce. I do not—if they are talking about it, they never do it public.

Alasdair Macleod: Yeah, right. A different department, I think, is the answer to that. I am fascinated in your analysis of the European gas situation. Yes, I mean, this was going to happen anyway because China and Russia are getting together to basically run the Asian continent. As I said earlier, the Asian continent is four billion souls. America is what, 350 million. Something like that? 400 million? Europe is about another 700 million.

I think between the EU and America we are looking around about a billion people. Asia, we are talking about four billion people and they are rapidly becoming prosperous. I mean, big middle classes all over the place. That is where the future is. Quite naturally—actually Russia and China have been working on deals like this cross-border gas supply deal. They have been doing things like hydroelectricity from Siberia into China, and so on, and so forth. It is an extension of what was happening anyway.

I think that the Ukrainian situation might have triggered the timing a little bit. But it is happening. Not only that, but when I look at what is going on in the Pacific with China irritating Japan, irritating Vietnam, irritating Indonesia, irritating the Philippines; actually, I think what she is saying is she is saying, for example, to the Vietnamese people, "Look, if you come into the Shanghai cooperation organization, come in with us and not with America. Then we will leave you alone. Because we have no interest in pursuing a debate as to who owns what if you are in the same camp with us." I think that is the natural outcome.

We are seeing huge growing tectonic shifts going on here with, I think a big new market in Asia. What you will find is that more and more energy will be diverted away from places like Europe in towards Asia, into itself. What we have seen there is the beginning of a trend. It is not just a one-off. I was interested about your analysis on the Dutch situation, the Netherlands situation, because yes, if we have got real declines in supply coming from that source, then we are going to have to bid up to get that stuff in from Russia. I do not know what the price would be. I mean, I would think that Europe might find itself settling above a market price in order to secure energy.

Chris Martenson: Well, absolutely. That field that I mentioned, the Groningen field was discovered in 1959, first put into production in 1961. Guess what, it is old. If I am in Europe, there is nothing more important than the energy situation. Period. End of story. I would be very careful about my relations with people who are in a position to ship me energy supplies. By the way, that is a shrinking list as we go forward. It is just, it is extraordinary.

That is first, second, and third, the top strategic priority that I would have if I was in charge of any continent or set of continents. It seems—it is amazing. I talk with bankers. I talk with politicians. I talk with a lot of people from Europe who it is just… They kind of all go, "Well, that is kind of interesting. Yeah. That seems–"

Alasdair Macleod: Yes [Laughs].

Chris Martenson: "–rather interesting."

Alasdair Macleod: And then dismiss it.

Chris Martenson: Yeah. I am sure somebody is looking at it. I am trying to find that person, right? Who actually is in a position of real power. Because the people who do talk about it are all of these sort of fringy geologists. People working in sub-departments and whatnot. But it really is going to be coming front and center. That is the key analysis here, which is if you are printing like crazy into the maw of a beast that feeds on energy and energy is going into a limited supply, there is just an amazing discontinuity between the reality on the one hand and the printing on the other.

By the way, it is the same exact situation that Japan—only Japan is doing it under even more dire circumstances than the U.S. But we are all doing it. It is just astonishing.

The bottom line is that what I see in this NIRP policy of the ECB, this increasing desperation to just get things working again as fast as possible is an absolutely profound inability to correctly diagnose where we are in this story. And just trying what used to work, because it used to work and nobody gets in trouble for trying what used to work. We will just try it harder. But where is the recognition that we are X many years into this particular crisis and nobody is really saying, "should we really just be doing more of what got us here?"

Alasdair Macleod: I think I have sort of thought up an analogy.

Chris Martenson: What have you got?

Alasdair Macleod: Let us assume there is a fruit machine. There are a couple of old pensioners there. They have put most of their money into the fruit machine. They have got just a little bit left. Already they cannot really feed themselves. They have the decision: Do we put our last pound or dollar into this machine in order to try and win our money back so that we can feed ourselves? What do we do? That is rather like the central banks. They run the fruit machine. They have played this bloody machine. It has actually got them absolutely no where. It has taken all of their money. It has chewed up all of their money. It is not giving much in return. Every time they get a little bit in return, they get sort of encouraged. They put a bit more in and it goes and they are now down to their last play. I think that is the analogy I would come up with. I cannot think of a better way of describing it.

Chris Martenson: So our instinctive hardwired gambling approach is going to be our downfall once again.

Alasdair Macleod: Well, I am afraid so [Laughs].

Chris Martenson: Alright, so as we get to the end of this, what are you looking for, in summary? What are you looking for to know that this is not working or that they are going to do more? Or that this is basically falling apart? You said rising gold prices obviously would be a great signal for a lot of people. Some sort of hiccup in the financial markets. But what are you looking for here? What are you keeping track of?

Alasdair Macleod: Well, I think the other thing that I am keeping track of is the economic performance of the major trading blocks. We see Japan is in a state of collapse. I mean, that is the only way to describe it. We have just discussed the European situation. We will not go over that again.

I look at the U.K.; on paper we look quite good. But I was actually thinking the other day. The banks have unwittingly put twenty-two billion of cash into the economy in a way in which they never foresaw. These are fines for selling unneeded insurance against the sort of losses on bank accounts or on credit cards. 22 billion is what they have had to pay their customers over the mis-selling of protective insurance. Now that money gets circulated a bit. In an economy of this size, 22 billion I think is roughly about 1.4 percent or something like that. Now given it gets circulated around a few times, you can take that out of our economy. Have we grown? I do not think so, really, because all GDP is, is it is a money total. I do not know that we are all that smart, either.

Then I look at the U.S., and it has been clear to me that your economy has been struggling hugely. I think that attempts to blame disappointing numbers on the winter weather and so on, and so forth, I think have missed the basic point. That is that the U.S. is unable to print its way out of trouble. That is already failing. All around, I see things beginning to sort of go over the cliff a bit. I am just watching those GDP numbers.

I would suggest that Peak Prosperity listeners bear in mind that when you look at the GDP, the deflators are always underestimated. If you have got a GDP that, say, rises three percent, it is probably contracting two or three percent if you put the true inflation number in there. So that is what I think that—other than the gold price, which I follow moment to moment—that I think is probably the thing I look at most.

Chris Martenson: Alright, those are some of the things I look at as well. I am watching credit spreads, which are just perilously narrow at this point in time. Credit spreads meaning –

Alasdair Macleod: Yes.

Chris Martenson: – The difference in the interest rate between ultra-safe and ultra-junky bonds. The ultra-safe should have a low rate. The ultra-junky ought to have a high rate. That would be a wide spread. But we have very narrow, tight spreads. We have low volatility in the equity markets. We have all time highs on the equity markets. We have all time lows on the spreads. It is just a spring coiled. It is priced for perfection.

The ECB moves in concert with what the Bank of Japan and the Fed have done, and have said there is something less than perfection under the covers that they are looking at. Because they are freaking out. They are doing things that—when your central bank is doing something completely unprecedented in world history, you might want to say maybe things are not completely rosy at this moment in time. It might be something else going on here.

So we have all our financial markets priced for perfection. We have got bankers that are scared on the other. I think anybody reading the smoke signals from the outside without knowing really what is happening under the covers fully, might want to just say, "this might be a good time to hedge my bets, cover my bets, and otherwise secure and batten the hatches down for myself, personally."

Alasdair Macleod: Become risk averse. Yes, I would agree with that analysis entirely, Chris.

Chris Martenson: Alright, well, Alasdair, thank you so much for your time. I am glad you are back off holiday so that we can get you lodged in front of your computer screen where you belong.

[Laughter]

Alasdair Macleod: Thank you very much… I do not think. It was very much my pleasure.

Chris Martenson: Alright, thank you.

About the guest

Alasdair Macleod

Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm.

Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director.

For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

Related content

6 Comments

KugsCheese's picture
KugsCheese
Status: Platinum Member (Offline)
Joined: Jan 2 2010
Posts: 711
Rickard's SDR Estimates

Interesting how the ECB "loan" estimates are inline with the IMF's SDR powder keg.  So if the IMF SDR get exhausted (these loans go down a drain) what happens after that?

Time2help's picture
Time2help
Status: Platinum Member (Offline)
Joined: Jun 9 2011
Posts: 555
Maybe...

KugsCheese wrote:

Interesting how the ECB "loan" estimates are inline with the IMF's SDR powder keg.  So if the IMF SDR get exhausted (these loans go down a drain) what happens after that?

SDRRs?

KugsCheese's picture
KugsCheese
Status: Platinum Member (Offline)
Joined: Jan 2 2010
Posts: 711
US Bank Gearing?

Anyone know what US bank gearing (leveraging) is?   Bear-Stearns was 37 when it imploded?  Gearing for Everyone saves the system?

searesponse's picture
searesponse
Status: Bronze Member (Offline)
Joined: Dec 3 2011
Posts: 29
The ECB does not want or need Inflation
McLeod is poorly informed. The ECB's intentions are not what he thinks. 
 
Commentators in the English-speaking world refuse to see that the ECB is on a radically different to path to the Fed. Mr Martenson and Mr McLeod make the mistake of viewing the ECB through the dollar lens (where nominal performance at all costs means they have no choice but to print money until their curriencies die) ... 
 
Mr McLeod ; why do you think the US banking system is in better shape the EZ's? Is it all the freshly printed 'capital' they were given? The ECB did not do the same (except some liquidity, as the system was not ready for EZ wide bail-ins). Soon it is ready : Deutsche Bank will be reduced to a speck of dirt. Plus many others ...
 
The ECB is going to radically shrink the EZ banking system - bail-ins are coming. Only approx. 5 per cent of EZ citizens have more than €100k in a bank (that number is decreasing) so it will not end the world.
 
Once again : bail-ins are coming to the Eurozone but NOT to the US or UK. This will strengthen the Euro, not weaken it. Also severing the links between sovs and banks.  
 
While the Fed and Bank of England save their banking systems and destroy the currency, the ECB is shrinking the banking system and protecting the currency. Which track would you prefer to be on? 
 
Mr.McLeod, I would like to make a bet with you (any stakes you like) : the Euro will never weaken significantly against the USD from here and we will soon see 1.45 ~ 1.55 ... After that gold and oil will no longer be priced in USD. 
 
Eventually, perhaps when Fed Reverse Repos spiral out of control (US rates MUST be kept positive at all costs, so that the world has a nominal risk-free asset), global capital will try squeeze into the Euro (inflows like the Swiss had 2 years ago, but X times bigger). 
 
Hold onto your hat Mr McLeod as the ECB will start purchasing gold on the open market as THEIR way to manage liquidity. What? They haven't told you in advance? 
 
Imagine what the reaction will be!
Imagine the gold price! 
 
Watch for the new economic system BuBa, ECB and BIS bring in as the dollar dies. Asia and the Oil countries already support it. A system that does not pretend inflation is the same as growth. 
 
kelly D Ritchie's picture
kelly D Ritchie
Status: Member (Offline)
Joined: Jun 11 2014
Posts: 1
Broken toys

It seems to me all the questions that are asked about a broken toys and then trying to fix the problem with another broken toy only to find out to broken toys  fixing broken toys will not create a fixed toy. 

Great you can talk about all the exchange systems I think you are asking the wrong questions thinking you will get the right answers. The real problem facing humanity is  Perceptions Trickery giving great advice. 

Wake up humans......... Information is moving to fast, to deep, to wide, and density getting very heavy. The problem is human not understanding we live in 1 world manipulated by countries, corporation, and banks. Deal with the problem. The speed,depth, width, and density  of misinformation. I like the call and so what? 

gnoll110's picture
gnoll110
Status: Member (Offline)
Joined: Feb 2 2012
Posts: 3
Bacon, ummmm!

Lets think about increases in bacon and beef prices for a moment.

Bacon up 53%, ground beef is up 35%. But what is the farmer getting? Getting barely cost recovery normally and below cost of production if they're forced to buy stock feed in a drought.

Say's Law assumes that there are perfect markets. A few big supermarket chains and meat processors in most national markets, makes the timely transmission of market signals back to the farmer, near impossible. Another example of broken markets. Remember it was the failure of Say's Law in the 20's and early 30's that lead to the dominance of Keynesian thought until the late 60's.

Keynes is taken out of context too often. He was born in 1883 and died in 1946. He dies early at 62, we never got to see what he would have advised in a booming post WWII economy. More importantly, he never lived in a world of (long term) increasing energy prices. His work is important, but often taken out of context, by both his detractor and 'follower'.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Login or Register to post comments