Economic Crisis

Rehab for the world economy

Drug: a substance taken for its narcotic or stimulant effects

Oxford Dictionaries

Unfortunately, many of us know a close friend or relative that has struggled with addiction. It destroys lives. A drug addict needs ever higher doses of narcotic stimulants to experience the same high. Eventually, their body can’t cope with the overdose. In the same way, a recent report reminds us that the world economy relies on ever higher doses of money printing and debt stimulus just to stay on an even keel. It’s already at the point of debt overdose, and urgently needs to get to rehab before it’s too late.

It may just be a coincidence, but there appears to be a literate bureaucrat, with a dark sense of humour, toiling away deep inside the US central bank.

The Federal Reserve has bought trillions of dollars of bonds in recent years with the aim of stimulating asset prices and the economy. These bonds are held in an account with the acronym “SOMA”. As the Federal Reserve’s own website explains:

The System Open Market Account (SOMA), managed by the Federal Reserve Bank of New York, contains dollar-denominated assets acquired via open market operations.

This name, “soma”, is the same one given to the happy pills used to control the downtrodden masses in “Brave New World”, Aldous Huxley’s novel about a future dystopia that was first published in 1932. Here’s an excerpt:

By this time the soma had begun to work. Eyes shone, cheeks were flushed, the inner light of universal benevolence broke out on every face in happy, friendly smiles.

Brave New World describes a world full of endless propaganda and social control. All people belong to fixed social strata or castes known as the Alphas, Betas, Gammas, Deltas, and Epsilons.

They wear colour coded uniforms to show their rank in society. Alphas are at the top and run everything, Epsilons are faceless drones that do the worst work. There is no social mobility. You’re either born into privilege or into drudgery, or somewhere in between. (Anything sound familiar?) Everyone is kept under control by taking regular doses of the soma drug, which keeps them “happy”. Or at least happily unaware of their predicament.

So what of the real world? You’re probably asking yourself what this has got to do with investment strategy.

Well, in recent years – just as addicts experiment with drugs – politicians and central bankers throughout the developed world have been experimenting with fiscal and monetary policy.

To preserve the illusion that all is fine they’ve printed vast amounts of money to help fund government overspending and prop up the prices of a range of assets, such as bonds, stocks and real estate. They’ve been showering the world with their “universal benevolence”.

“No shoving there now!” shouted the Deputy Sub-Bursar in a fury. He slammed down the lid of his cash-box. “I shall stop the distribution unless I have good behaviour.”

The Deltas muttered, jostled one another a little, and then were still. The threat had been effective. Deprivation of soma – appalling thought!

“That’s better,” said the young man, and reopened his cash-box.

The cash-box is kept open, and the Deltas and the rest of the castes (voters and investors) are expected to behave themselves. All is supposed to be well.

The alternative would have been a bigger economic crash. So surely these policies are okay if they prevent or reduce the pain of recession or depression?

But they aren’t.

Marc Faber, a renowned investor based in Asia, has apparently put it another way. He thinks that what the world’s central bankers are doing in each major downturn or crisis is like looking down from a high diving board. They don’t want to jump from so high up, and they climb to an even higher diving board.

In other words, instead of unwinding the already huge debt pile they follow policies that seek to add more to it. They do this to preserve their own necks, and because they think it will be someone else who eventually makes the dive, long after they themselves have moved into highly paid consulting jobs.

And as any swimmer knows, the higher the height from which you jump, the deeper that your downwards momentum will drive you below the waterline.

Eventually there will be no higher diving board to climb up to. The final dive will be monumental, if not a winner of gold medals. And as any swimmer knows, the higher the height from which you jump, the deeper that your downwards momentum will drive you below the waterline.

Put another way, every time the world’s policy makers attempt to deny their debt soaked reality, and inject a bit more stimulus into the economic veins, they may succeed in putting off the final day of reckoning. But they also ensure it will be a much more severe day, and a much more damaging reckoning, when it eventually arrives.

A new report from the International Centre for Monetary and Banking Studies (ICMB), aptly named “Deleveraging? What Deleveraging?”, highlights how things are getting worse. The world is more awash with debt than ever before, seven years after the last major debt-induced crisis. The following chart from the report sums it up very simply:


In short, the level of world debt in relation to GDP continues to grow at an astounding pace, and is at all time record highs. And this chart leaves out financial debt, which is mainly the debt owed by banks. But it includes all debts of governments, non-financial businesses and individuals. And that lot, in relation to the size of the economy, had gone from 162% of GDP in 2001 to 212% of GDP in 2013.

That means the world is nearly a third more indebted in relation to economic production than it was at the turn of the century. And don’t forget the economy has grown too, meaning debt levels are growing much faster than the economy is expanding. Put another way, the world economy needs ever more amounts of debt to induce ever smaller incremental increases in production.

The truly excessive debt levels are mainly a developed country problem, although China’s private debts have also expanded quickly in recent years. Developed countries have a debt-to-GDP ratio of 270%, compared with 150% in emerging markets, again excluding financial sector debt. Including financial sector debt the situation is even worse. The ratio is up at 385% across developed countries as a whole.

As financial debt has come down slightly since the global financial crisis of 2008, relative to GDP, government debt has expanded rapidly as countries continue to run huge budget deficits. They have to borrow ever more to fill the gap between government spending and the money collected from taxation.

Much of that government borrowing has been funded directly or indirectly by money printing, otherwise known as quantitative easing (QE). But using a sophisticated sounding name doesn’t change the nature of the beast. QE is still just creating money out of thin air to prop up the government and domestic asset market prices.

The world, especially the developed world, is truly addicted to money printing and debt.

The world, especially the developed world, is truly addicted to money printing and debt. It’s the only way that policy makers feel that they can control things and pacify the markets and the voters, whilst constantly telling everyone that things will be okay. It’s a brave new monetary world, where money printing and debt take the place of propaganda and drugs, although plenty of both of those is evident as well.

And it’s not just governments that borrow and spend too much, but ordinary people too. As my friend Bill Bonner has often put it, people have been buying things they don’t need with money they don’t have. (Bill is the founder of Agora Inc., a publisher of financial newsletters.)

In one excerpt from Brave New World the fictional soma drug is described like this:

And if ever, by some unlucky chance, anything unpleasant should somehow happen, why, there’s always soma to give you a holiday from the facts. And there’s always soma to calm your anger, to reconcile you to your enemies, to make you patient and long-suffering. In the past you could only accomplish these things by making a great effort and after years of hard moral training. Now, you swallow two or three half-gramme tablets, and there you are. Anybody can be virtuous now. You can carry at least half your morality about in a bottle. Christianity without tears-that’s what soma is.

With apologies to Huxley, let me try to re-write that passage as it applies to the global financial system:

And if ever, by some inevitable chance, anything unpleasant should somehow happen, why, there’s always money printing to give you a holiday from the facts. And there’s always debt to calm your markets, to reconcile you to your over-spending, to make you feel wealthier and ready to borrow and spend. In the past you could only accomplish these things by making a great effort and after years of hard work. Now, you print two or three trillion dollars, and there you are. Anybody can be wealthy now. You can derive at least half your success from money printing. Growth without tears – that’s what debt is.

Except there will be tears, and worse. Each post-binge crash becomes bigger and and harder to control. The subsequent doses of money printing and debt stimulants are ever larger. Eventually the financial system will overdose on debt, and then it will be game over. In the post-crash carnage, holders of physical gold will have the best chances of financial survival.

As Amy Winehouse, a British pop musician, sang in her song “Rehab” in 2006: They tried to make me go to rehab, but I said “No, no, no”.

The world’s financial and economic system needs a prolonged stint in debt rehab. But the world’s politicians and central bankers are in denial of their addiction. Just like Ms. Winehouse they are also saying “No, no, no”.

They should be saying “Now, now, now”. That’s if they could face up to the facts.

Amy Winehouse, after years struggling with alcohol and drug addiction, died from alcohol intoxication in July 2011. She was aged 27.

Need I say more?

Stay tuned OfWealthers,

Rob Marstrand

PS: You can find out more about Huxley’s book Brave New World here, and you can watch a BBC TV adaptation, made in 1980, here. (Just remember, it was made in 1980, at the start of the decade that style forgot.) The ICMB report on debt can be found here.

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.