Bad Central Bankers.
But are they really? The indispensability of debt in human condition.
The popular opinion of the post-GFC world is that of a world controlled by a convoluted web of opaque financial connections assisted by a few central bankers on top.
In this world, money is an illusion freely manipulated by the central banks in ways that benefit the wealthy, but harm the poor. The emergence of bitcoin, the popularization of financial history, these are all reactions to the swelling mass of imaginary money that is inflating away the value of people’s savings.
This Occupy Wall Street mindset seems to be quite relatable, but to conclude that the monetary mess we are in is the fault of central bankers is unfair.
Central banks have inherited a system that cannot be reversed or diminished, it can only be maintained by making it grow larger. Even the inception of this system might have been an unavoidable consequence of human condition — our predisposition to be driven by excess.
Yuppie 1980s
You will know from what is now a popular literature on financial history that even during gold standard, the financial system was a carefully watched set of decisions by bankers focused on preserving the value and repayability of debts.
But it is after the abandonment of gold that the abstraction and expansion of money really took off. As explained in Even Punk Has Become Financialized, when the post-war economic miracle of 1950s-60s came to a halt in the stagflationary 1970s, financialization of Western economies was seen as a way out.
That is, it was allowed and actively endorsed that the amount of debt in the system grows, and that the industry of servicing, cutting, slicing and repackaging that debt — the financial industry — grows larger and more powerful.
This was done in many ways. The rise of bank holding companies, the deregulation of credit cards and the reduction of collateral requirements were the sorts of regulatory relaxations invented by the political and bureaucratic interplay of the time.
This you could say was the equivalent of putting the faltering economies on steroids. The vastly increased capacity of pretty much everyone to borrow (and the moral nod to do so from above) propelled spending and investing, letting the markets go off limits. Welcome to the yuppie 1980s.
The steroids have colossally increased the size of the debt cycle on the way up and, by the same token, the cataclysmic danger that it would pose, had it ever been let to fall. Thus the central banks were left with no choice but to be always ready to hold the floor under the markets.
Any sign of trouble would lead them to reduce the rates, and/or buy things from markets. Even Paul Volcker, considered a relentless fighter of inflation, did much more than just raise rates during his time, and there is a view that he prepared ground for financialization by creating the ‘monetary policy without money’ by abstracting/detaching policy rate from a real need to constrain liquidity.
Human condition
A fundamentally flawed system? Maybe, but equally you could ask what are the alternatives? The forever-rising-debt-managed-inflation-rate system might be bad, ok, but isn’t it an essential element driving people forward?
Humans are driven by excess. Debt magnifies the size of the upside and downside. It makes returns larger and losses faster.
It also transfers resources from mostly bored savers without ideas to excited entrepreneurs full of ideas. The magic of finance is transforming (cutting and slicing) claims into investable products.
Perhaps a fund would not want to buy a mixed batch of very short-term loans borrowed by retail customers to buy everyday things. But when its transformed, say by Affirm, into an asset-backed security, which has complete data about its users to be able to separate higher risk borrowers (e.g. a buyer of suit is likely to go for a job interview, i.e. is currently jobless) and prime borrowers (a buyer of peloton?) into different tranches, the fund might like this ABS. It might perfectly fit its risk-return requirements. (Also read Diff’s much better article on Affirm’s off-balance sheet maneuvering here.)
Although inefficient and leading to constant boom-busts, debt is the indispensable carrot and stick that guides human race forward. (Have central bankers heard of The South Sea Bubble?). And when things turn bad, central bankers must be called to rescue, using their magic to push debt into the system.
Debt & Crypto
As explained in Bitcoin Standard Has a Debt Problem, no one talks much about the question of debt in the promised land of bitcoin standard. The theoreticians of bitcoin mostly reject the artificial debt creation and perceive the debt cycle as something evil.
The emergence of crypto was inspired by the distrust in bankers after the financial crisis, an overwhelming belief that people’s lifetime earnings have been misused in opaque banking games.
A system of many layers of highly complex products towering on top of each other, exchanged between thousands of counterparties extracting profit, while leaving people holding the bag, when things fell apart.
But little more than a decade into its existence and crypto has recreated the domino effect on its own. Taking money from people and lending it into opaque structures, while creating a convoluted web of counterparties, crypto is reliving the financial history on fast forward.
That persistent re-emergence of debt in opaque forms that cause bubbles and crises seems to be a part of human condition.
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