Bank Calls for Global Overhaul

From the May 2006 Trumpet Print Edition

The world’s economic and monetary system is broken. Granted, this is not new news for regular Trumpet readers. What is new is that, in an abrupt change of stance, one of the world’s top banking authorities, the Bank for International Settlements (bis), now warns of a dangerously unbalanced world economy and is calling for an “overhaul of the current global economic system” (Telegraph, February 20).

Furthermore, the bis has suggested that many of the world’s nations should abandon their currency and adopt one of a small number of formal currency blocs “based on the dollar, euro, and renminbi or yen” (ibid.).

For a major bank to call for such drastic action, it must recognize a big problem. That problem is soaring debt levels.

The bis specifically accused the Bank of England’s inflation policies for being responsible for Britain’s record household debt levels, saying that by “pushing interest rates so low [the Bank of England] has encouraged the public to take on more debt” and has created dangerous imbalances (ibid.).

When a central bank keeps interest rates low, it makes money less expensive to borrow. Consequently, people are more willing to take on extra debt to fuel spending. This increased supply of easy money and the subsequent extra spending translates into increased demand for assets and results in rising asset prices—such as in the housing market.

Further enticing people to take on more debt, as pointed out by the bis last year, is the fact that the “world’s central banks … [have held] interest rates at or below the rate of inflation” (ibid., June 29, 2005; emphasis ours). The bis specifically rebuked the United States for “running a loose monetary and fiscal policy.”

The European Central Bank has noted that, in Europe too, interest rates are at “historical lows” and when adjusted for inflation they are practically zero or negative—just as they are in the U.S.

When inflation-adjusted interest rates are zero or negative, it destroys people’s incentive to save. For example, if you were to put $100 into a savings account that earns 3 percent interest, after one year you would have $103. However, if inflation is running at 4 percent, after one year (and taking into account your interest earned) your $100 has actually become worth only $99 in inflation-adjusted terms.

In other words, by saving money, you actually lose money.

In its recent report, the bis noted that the debt problem went beyond Britain and was especially bad in “a number of English-speaking countries [where] a decade-long reduction in the household saving rate and a significant increase in consumption” has been occurring (op. cit.).

As reported by the Telegraph, the bis highlighted the fact that the countries with the largest external deficits—the U.S., the UK, Australia and New Zealand—also are the countries with the largest “internal imbalances,” such as rising housing and other asset prices. Accordingly, rising asset prices “have led to higher perceptions of wealth, and more spending”—and more debt (ibid.).

But compounding the negative household savings rates in the English-speaking countries is that, on a federal level, these same countries are also running deficits and holding increasingly large debts—further contributing to imbalances like asset bubbles.

This is especially so in the U.S., where the current account deficit is now at a record level of almost 7 percent of the country’s gross domestic product (value of all goods and services produced in one year). When other countries, such as Argentina, have approached and exceeded this percent, their currencies have experienced a marked drop in value.

So just where are all these imbalances leading? To a huge crash—the biggest ever.

What is preventing a crash for now is the fact that demand for U.S. dollars is still strong because the dollar is the world’s reserve currency—a status now being challenged. Once that status deteriorates, then watch out!

As America’s economic imbalances and debt build up, even its current status as the reserve currency controller will not prevent it from becoming vulnerable to currency collapse and hyper-inflation.

Since raising taxes and slashing benefits and services are tantamount to political suicide, watch for government leaders to try to take the seemingly easier path out of debt—the path they have already started down—the path that might be hid for a little while longer, the inflationary path.