What Could Possibly Go Wrong?

From the emergence of a truly global economy on this planet until now, that economy as a whole has never looked better. As an example, the title Goldman Sachs put on its official analysis for the global economy for 2018 is, “As Good As It Gets.”

In almost every geographical region and within every category, from the least to the most developed nations, things are looking up. Of course, there are laggards, but there are also nations in every category growing faster than the average.

At first glance this happy state could be seen as a global triumph of trickle-down economics. After all, that has always been the only model for the global economy. When the richer nations have done better the poorer nations have always shared peripherally in the good times.

This time, though, something really is different. Economic growth is more widely distributed than ever. Poverty is in retreat as never before in nations like China and India. This time poorer nations are experiencing, not just an increase in income, but an advance in development.

Economics being the dismal science, the question must be asked: What could possibly go wrong?

A chain is only as strong as its weakest link. An economy is not a chain, but to see its vulnerabilities we must look at the margins of the economy, those places where it is most fragile, those areas where the forces of prosperity encounter their biggest challenges. Areas of fragility do not necessarily portend disaster, but in assessing the prospects of the economy they must be taken into account.

The global economy, as we have learned from bitter, recent experience, is subject to cascades. Like a loosened snowball atop a white-capped mountain, a seemingly slight disturbance can lead to an avalanche of economic destruction.

For purposes of this little analysis, there are two kinds of people/households in the world. There are those who are financially secure, who have sufficient financial resources to weather monetarily, at least, anything life can throw at them, and there are those who are at risk.

People who are at risk are the global economy’s greatest immediate vulnerability. The at-risk among us range from those who can survive all but the worst financial tempests that life can devise to those who are barely keeping their heads above water in even the best of times. Clearly, to one degree or another the at-risk are almost all people.

The biggest cause for concern in the global economy as a whole is debt. The global economy depends on the global financial system, and the global financial system is a system of debt — a huge, constantly growing mass of debt, public and private [re. this graph]. Rising incomes make carrying debt easier, but that much debt is of itself a very real threat. How might at-risk people cause that mass of debt to come crashing down?

Though the global economy is doing well, at-risk people everywhere are hard-pressed. Many are using debt, not for investment, much less luxuries, but to make up the difference any time any out-of-the-ordinary expense arises or, say, missing work for a day or two because of personal illness or the illness of a child.

If the people in that situation were to receive significant increases in their incomes they could begin the hard slog to a more secure financial place (which can be achieved at relatively modest — but not minimal — levels of income: re. this article). If the share of total income they receive continues to lag behind their basic needs, they may very well succumb to economic exhaustion.

Income is only one of their worries. Another is inflation. Central banks everywhere have been working tirelessly to funnel money into the global economy for years and even decades. The generally stated goal in the developed nations is an inflation rate of between two and two-and-a-half percent.

One danger that lurks in accomplishing that goal is one that some people have been warning against the whole time central banks have been desperately seeking inflation: with so much money being created, by the time any inflation appears it could be too late to prevent a monetary conflagration. Moreover, while there has been a lack of inflation in developed nations, that is not true for the global economy as a whole. Rather, at the global level the rate of inflation has not been as low as 2.5% recently. [re. this chart]

The reader will note that the chart cited does show inflation stabilizing. That is consistent with most economic forecasts out there. I must emphasize that this analysis as to what could go wrong is in that sense contrarian.

One reason so much money has created so little inflation to this point in developed nations is that a vast amount of money — actual cash — is ‘sitting on the sidelines’, as financiers like to say. For example, I saw a recent estimate that the Fortune 500 corporations alone have $2.3 trillion dollars in cash on hand — even before the huge tax break corporations (and wealthy individuals, who also have lots of cash on hand) was recently handed in the U.S.

If significant inflation were to develop, meaning that money would be losing significant value, those holding cash would be pressured to put that money to some use. Once significant amounts of that idle money started entering the economy, a tendency towards a self-perpetuating inflationary cycle would develop.

To be sure, central bankers are not unaware of that threat. In the U.S. the Fed has already begun raising short-term interest rates. That tends to dampen inflation by making purchasing things using credit more expensive, and therefore less likely. It undercuts total demand, lessening the pressure on prices.

Central banks can also fight inflation by simply requiring banks to keep more cash on hand. If the choice bankers face is to lend out money at fixed rates in the face of a rising rate of inflation or sit on the money, the ‘opportunity cost’ of sitting on that money, in the form of revenue they have forgone, is one thing. They are foregoing some revenue, but at the same time refraining from lending does help to dampen inflation, which is the problem they are confronting.

That was the choice bankers faced from the 1930’s until the financial system was deregulated over the ‘80’s, 90’s and early 2000’s. Nowadays, however, banks are free to speculate with the money they are holding for people. That increases, in bankers’ eyes, the opportunity cost of letting the money just sit there. In an inflationary economic environment, that makes the possibility of the banking system requiring bankers to sit on the money they are holding for people less likely, meaning the banks would be more likely to be contributing to inflationary pressures, not dampening them.

There is one other thing central banks can do to fight inflation. They can sell assets, thereby absorbing money from the economy — and central banks have been stocking up on those (re. this article). The problem is that to sell those assets they must have buyers. Those assets were formed in the time of extremely low rates of interest, and would not provide a return suitable for an economy with significant inflation. Presumably, the demand for those assets would be negligible.

Those assets are securities. That is, they pay interest. In addition to the vast stock of securities on hand, new securities are being created all the time, as when central governments borrow from central banks when they spend more than they have collected in taxes. Like anything else, when the demand for securities is low and the supply of them is large, their prices fall. When the prices of securities fall, that of itself raises interest rates.

So, one way or another, interest rates will be rising. That helps combat inflation.

It will also add to the forces that financially squeeze people who are at risk. Other than mortgages, the credit they use is in the form of short-term loans and credit cards. The latter have interest rates that are multiples of some short-term rate, usually the LIBOR (which is the shortest term there is in lending; it is the interest rate banks charge each other for overnight loans in the financial market in London).

In summary, the current situation contains a three-pronged threat to the at-risk among us. First of all, many at-risk people are in dire need of an increase in income already. Without it, any continuing inflation at all, especially in the basics, would be enough to ruin them financially. If inflation were to develop, that would make making ends meet from month to month increasingly difficult. At the same time, ising rates of interest, whatever their source, would make the debt people use to leverage the income they have to cover short-term shortfalls increasingly expensive. If those trends develop, grow strong enough, and last long enough, and incomes do not increase sufficiently, those people will have no choice but to start defaulting — simply stop paying on their debts.

If defaults were to increase significantly, lenders would seek to recoup those losses within that portion of their business. Offering seriously at-risk people new loans at higher rates of interest is not a formula for success. Yet, the less at risk people are, the less need they have for new debt. So lenders’ primary option to recoup those losses in that part of their business would be to increase rates of interest on existing debt.

There are two places where the rate of interest on existing debt can be raised. One is adjustable-rate loans such as mortgages of that kind. Those, however, have built-in limits on how big the changes can be.

The other place lenders can raise the rate on existing debt has no limit on it. That is the interest charged on credit card balances. Again, it is tied to a short-term rate, but if that rate is the amount banks are charging one another for money, it is only the moral fiber of the bankers that could prevent manipulation of that rate for their own benefit. (Banks have already paid fines recently for doing precisely that.)

It should be noted that credit card debt is signature debt. There is no collateral for such credit that is asked or promised. When people default on credit cards they can be sued, but there is no ready remedy for the lenders. Other than the threat of being sued, there are only two factors that enforce credit card contracts.

One is the power credit card companies have over a person’s credit score. Given the importance of that item in a person’s life nowadays, even affecting prospects for employment, that is no small bit of power. Still, if it comes down to protecting that abstract number or providing the basics of life for one’s family for just one more month, that isn’t much of a choice.

The other enforcer of credit card contracts is the moral obligation people have to pay their debts. Contracts based on moral obligation, though, are only valid if both sides live up to their moral obligations. For one side to default morally frees the other from the moral obligation underlying the contract.

Not even the most heartless financier can suggest that in the last few decades the banks have maintained their side of that obligation. Their nefarious, reckless, even in some instances blatantly illegal profit-seeking has broken that moral bond while it has inflicted incalculable material damage on people. That includes, but is not limited to the banks’ role in the financial shenanigans that led what we call the Great Recession.

Credit cards are the primary form of making-do debt that hard-pressed, at-risk people in the more developed nations employ. Increasing the already exorbitant interest rates on credit cards could break the financial backs of that group of people. So credit card debt could be the snowball that would trigger an economic avalanche that would crash the global economy.

In the U.S., the bell weather of the global economy, and where the at-risk are as hard-pressed as they are in any developed nation, there is one additional threat that requires mention. It is health care.

The recent tax bill made it possible for insurance companies to sell policies that do not cover all of the conditions specified in the Affordable Health Care Act. Presumably, such policies will be less expensive than more comprehensive policies. Thus, those responsible for the tax bill could claim to have lowered premiums.

One of the most overlooked effects of the AHCA, however, has been to reduce dramatically the number of health-related financial defaults [re. this article]. Health care is so expensive that any major crisis in any at-risk household can be totally financially devastating. People who buy flimsy insurance policies find that when a crisis arises, the policy, though it was never cheap, is basically worthless. With an aging population that will be experiencing more and more health crises, that is another snowball atop the constantly growing mass of debt that is the global financial system on which the global economy depends.

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