Easy money creates unsustainable bubbles was the conclusion of a documentary film recently broadcast by DW, the respected German news channel. In the aftermath of the great recession (2007-10) the European Central Bank (ECB), in concert with the US and UK pumped huge amounts of money at ultra-low interest rates. The result of this bold policy intervention-quantitative easing (QE) -was that money sloshed around pushing up asset prices. Rich investors, individuals and institutions, gained handsomely. Houses in tony neighbourhoods were bought and sold ata tidy profit. Posh houses were shown to be lying vacant as these were snapped up with a speculative motive. The piece brought burning ethical and economic questions to front and centre.
The storied private equity firm, KKR, reaped 800 per cent windfall just by flipping a company in the course of a few years. This is not an isolated case of garnering windfall gains by exiting this way. When companies change hands, workers become pawns. It is well-established that upsized returns are possible only on the back of leverage. No wonder then the common man vehemently opposes a system that allows a chosen few to gain such eye-popping un-earned returns.
To be fair, pockets of Europe are not out of the woods yet. Furthermore, inflation is timid. A likely cause could be capacity under-utilization. It is feared that raising interest rates at this juncture would nip any nascent recovery. In such a context, the term 'secular stagnation' has gained currency, postulating mediocre growth for the West in the foreseeable future. To the extent that inflation acts as a tax on savers, Europe has been spared this distortion.
The ECB is guilty of abetting a housing crisis in large European cities. Outside the ECB's remit, the London property market has similarly is red hot. First-time buyers and young families have been priced out. Some have moved to the country because a nice farm can be had for the price of a modest flat in London. London is special, central London more so. However, with Brexit looming resulting in a messy divorce, experts warn of an exodus of financial institutions from the City taking thousands of lucrative jobs away to other European financial centres. On the flip side, price and rent appreciation will be tempered.
A real eye-opener was that global debts surpassed world output or gross domestic product GDP (gross domestic product) by 2.67 times in 2014.Simply put, too much money is chasing too few goods. A more apt measure would have been to juxtapose incremental debt, because like GDP it is a 'flow' measure. Most of the debts now outstanding were used in acquiring assets.
Moreover, the notional value of derivatives presently stands at an astronomical Euro 705 trillion. Warren Buffet compared derivatives with weapons of mass destruction and with good reason. The Dodd-Frank measures in the US should hopefully rein in some of the worst excesses. The Trump administration, however, wants to roll back Dodd Frank. Insinuation was that the ECB is perpetuating social inequities. Some even likened the goings on as a Ponzi scheme.
The documentary reminds us that ordinary savers, retirees especially, get a raw deal when interest rates are low. Annuity payments nosedive in tandem. It is likely therefore that, on a net basis, savers' returns are negative. Savers are in effect subsidising borrowers as debts (used as a fulcrum in the acquisition of assets) yield lucrative returns. Pensioners ruminated on the days when bank rates were higher. DW sounded a dire warning: easy money has to stop soon. Otherwise, loan-to-value ratios would balloon and lenders would be forced to call in the loans. Borrowers would then rush for the exits resulting in a downward spiral of property prices.
Falling house prices make owners feel poorer. Domino-like effects ripple through the economy. We shudder to think about the housing crisis, pre-cursor to the great recession. With tepid interest rates, central banks have now basically run out of ammunition for pump priming. This is very concerning because business cycles are not dead.
Indirectly, the film takes a swipe at fractional reserve banking, the unique power of the banking system for creating deposits. New deposits create fresh money and ad infinitum.
Can parallels be drawn between Bangladesh and the European Union (EU)? Banks in Bangladesh chase large and successful corporations. What about the rest, meaning micro, small and medium-sized businesses? A lot of potential is lost when banks cherry-pick the best clients. Management is blind toward social justice and ethics.
Bank deposit rates in Bangladesh have shown a downward trend for several years, thus, alarming the average savers. At about 4.0 per cent, it is below the inflation rate hovering around 6.0 per cent-7.0 per cent. This has led to a growing chorus in favour of higher profits on government savings schemes.
Speculation of the magnitude mentioned in the documentary is unknown in this country; flipping properties is also not the norm. We are spared big-time job losses also. On the other hand, loans valuing billions of taka have gone astray raising questions of moral hazard and adverse selection. There is no derivatives market in Bangladesh as yet.
Due to our lack of financial sophistication (call it backwardness), Bangladesh was not hammered by the great recession. The lesson: so long as there is symmetry between the national output and money supply ethical and economic pitfalls can be held at bay.
Raihan Amin is Visiting Faculty, International University of Business Agriculture and Technology.
