The monetary distortions,
imbalances and perverse incentives are finally bearing fruit: trade wars.
What ignites trade wars? The oft-cited
sources include unfair trade practices and big trade deficits. But since these
have been in place for decades, they don't explain why trade wars are igniting
now.
To truly understand why trade
wars are igniting and spreading, we need to start with financial
repression, a catch-all for all the monetary stimulus programs launched
after the Global Financial Meltdown/Crisis of 2008/09.
These
include zero interest rate policy (ZIRP), quantitative easing (QE), central
bank purchases of government and corporate bonds and stocks and measures to
backstop lenders and increase liquidity.
The policies of financial
repression force risk-averse investors back into risk assets if they want any
return on their capital, and brings consumption forward, that is, encourages
consumers to borrow and buy now rather than delay purchases until they can be
funded with savings.
As Gordon Long and I explain in
the second part of
our series on Trade Wars, financial repression generates
over-capacity and over-consumption: with credit almost free to
corporations and financiers, new production facilities are brought online in
the hopes of earning a profit as the global economy "recovers."
Soon there
is more productive capacity than there is demand for the good being produced:
this is over-capacity, and it leads to over-production, which as a result of
supply and demand, leads to a loss of pricing power: producers can't raise prices due to global gluts, so they end
up dumping their over-production wherever they can.
If the
producers are state-owned enterprises subsidized by governments and central
banks, these producers can sell at a loss because their only function is to
sustain employment; profitability is a bonus.
Over-capacity, subsidies and
over-production force corporations to slash costs to maintain profitability. Cost-cutting is
a never-ending process in a world stuffed with too much capacity: labor costs
are slashed by offshoring factories and offices; quality is reduced by buying
the cheapest low-quality components and scrimping on quality controls, R&D
is trimmed and testing is hurried to get the next product cycle out early
enough to maintain a slight competitive advantage.
As profits erode due to
over-capacity, corporations turn to financial engineering to
boost profits: profits come from either accounting trickery or stock
buy-backs that reduce the number of outstanding shares.
With credit cheap and profits
scarce, corporations borrow to survive.These become zombie corporations, kept alive only by
super-low interest rates and ample credit.
Meanwhile,
consumers have over-borrowed and over-consumed, taking on more debt than would
have been possible in the pre-financial repression days.
As a direct result of these
stimulus policies, private and public debt loads are expanding at rates far
above the expansion of the real economy. This is why we read that each new
dollar of debt is generating almost no real-world gains, as debt service
consumes most of the "new money."
Over-capacity leads to some
nations over-producing, and cheap, easy credit leads to over-consumption in
other nations. Both imbalances are the result of vast distortions in the
incentive structure of the global economy, distortions created by the policies
of financial repression: zero interest rates, ample liquidity, financial
engineering, government subsidies for over-production, central bank policies
keeping zombie corporations alive and so on.
As these distortions and
imbalances start destabilizing domestic economies, political leaders turn to
trade wars to stem the erosion of the domestic economy. Trade wars are
the inevitable consequence of monetary stimulus that creates perverse
incentives to borrow more than is prudent, over-produce, over-consume and use
accounting trickery and financial engineering to maintain the appearance of
fiscal health.
The monetary distortions, imbalances
and perverse incentives are finally bearing fruit: trade wars.
Were Trade Wars Inevitable?
My new book Money and Work Unchained is $9.95 for the Kindle ebook and $20 for the print edition.
My new book Money and Work Unchained is $9.95 for the Kindle ebook and $20 for the print edition.
Read the first section for free in PDF format.
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