By John Bolton*
You've no doubt heard the expression before so let’s start by defining it. Fiat money is paper money that comes into existence by government law. It is not valued to any ‘objective standard’ to say a commodity like gold or silver, so governments can produce as much money as they like. When you hear the expression ‘printing money’ that’s what is being referred to.
The widely held view amongst economists is that if you increase money supply too much you get high inflation. So the theory goes, but in practice this time it’s playing out different. The increase in money supply has poured into assets like shares and real estate causing a massive rise in asset price (but this isn’t considered inflation.) It has not translated into general goods and services.
I think the length of time we’ve had in this low rate environment is worrying. It feels like we have adapted to, and almost become dependent on, low rates. There’s a risk that we can’t break the shackles without serious consequences.
House prices cannot increase faster than economic growth indefinitely. Increasing leverage and external capital (creating money) are the only two things that drive house price growth above economic growth. The main driver over the past two decades has been leverage which is both constrained and constraining.
With Kiwis owing over $200 billion in residential mortgages it wont take much of an increase in interest rates to constrain consumer spending. We’re also running out of capacity to borrow more even at low interest rates.
Low mortgage rates 'our economic meth'
As borrowers low mortgage rates are exciting and are broadcast as ‘headline news.’ It has become our economic ‘meth’ and it blindsides us to the wider long term consequences. How often are you hearing that we’ll be ok because interest rates can stay low for as long as it takes. What if it always takes until it's too late?
It is challenging to find a healthy yield on any form of investment, and so in pursuit of yield the markets are mispricing risk. How do we deal with an aging population coming out of the work-force and low yielding income? There is $146 billion in retail bank deposit earning gross interest of 2.50%. A retiree with $1 million in term deposits will earn $26,000 per year after tax. In real terms $15,000 of that is getting eroded by inflation.
We have all of this printed money pouring into assets like shares, bonds and real estate that is causing no generalised inflation. We then have investors chasing lower and lower yielding (or riskier) assets. We have retirees sitting on a combination of over-inflated assets and low yields. Then those of us working collectively have more debt than during the Global Financial Crisis.
House of cards anyone?
The final piece of the picture is technology led deflation. We are at the start of a new era of robots and artificial intelligence and exponential technological change. It seems like a lifetime ago but the first smartphone was only launched in 2007. Mobile phones as a category only became commercially available in the mid 1980s.
Technology is going to have a profound impact on the labour market. Most jobs we have today will not exist in 30 years’ time, and how on earth do we transition an economy through that at the same time as dealing with extraordinarily high debt-levels and asset bubbles?
I have a sneaky suspicion that our current monetary system (and possibly the way governments work) will not survive what’s coming. History shows us that change is inevitable. Is it that time again? Is fiat money coming to an end?