The context is the post-global financial crisis (GFC) expansion of the money supply where the Federal Reserve has injected vast quantities of capital into the financial system for the stated purpose of maintaining liquidity and preserving the smooth functioning of financial markets. The liquidity has ended up in risk assets – equities predominantly (public and private) – whose investment custodians have come to rely on the much-discussed Fed put and have also become accustomed, because of that reliance, to buying the dip whenever markets declined.
A zero interest rate environment, while pleasant for borrowers of all stripes – government included, has distorted the investment landscape by forcing investors into risk assets offering higher returns – the so-called TINA (there is no alternative) approach.
This period of easy money has witnessed overall US Federal Debt to GDP growing from approximately 67.7% in 2008 to 137% in 2021. This average growth of 5.6% compares to the average growth in GDP over the same period of 1.6%. Why worry? After all, the USD is a global reserve currency and the US can continue to print money to service debt…as long as markets tolerate it. Japan has a debt-to-GDP ratio of 231% and it’s doing fine…
Stepping back for a minute, we should reflect on why the US is the global reserve currency. After WWII, the Bretton Woods conference established a system where the US would promote world economic recovery by allowing the rest of the world to export more or less everything it produced to the US, in exchange for collaborating with the US in its struggle against the Soviet Union. The US would guarantee, with its unparalleled naval strength, the shipping lanes that facilitated worldwide trade and hence allowed the growth in globalization. Everyone benefitted.
An additional step, after the US abandoned the gold standard, was to effectively move to a US dollar-centric petrodollar standard where oil would be priced in USD. Since oil is in everything – plastics, fuels, agriculture, electronics – and because the world has to pay for oil in USD, the world is dominated by USD. At times, this has been painful – for everyone except the US. When the USD is strong, everyone but the US suffers because their currencies weaken against the dollar – they have to sell their currencies to buy the dollars they need to buy oil.
In terms of energy and climate, it has been known for some time that carbon fuels have been making our environment worse to live in. The planet is indifferent, but we are not. Unfortunately, the transition away from carbon-intensive fuels is a slow one. It would be quicker if we embraced nuclear energy, but ill-conceived fears about the environmental risk of nuclear energy and nuclear waste have resulted in less of this zero-carbon, extremely efficient energy source than would have been ideal. So, coal is better than wood; oil is better than coal; gas is better than oil and renewable energy is better than gas. Nuclear is better than all these, but…
We have become accustomed to thinking of the world economy in terms of financial assets, bond and equity prices, and the role of central banks in keeping all this in balance. The GFC underlined the correctness of this understanding. Central banks bailed out banks and banks bailed out the economy.
Now, coming back to today, two things have come to a crisis point at the same time; the overwhelming burden of debt in developed economies; and the shift away from economies being driven by financial assets to energy as the primary driver.
