Short answer:
My statement was premised on us being on the crest of a long-term debt cycle, where the levers used by a central bank during a recession are no longer available to it due to interest rates being too close to 0% and the debt-burdens held by corporations and individuals being too high to be managed/sustained by merely reducing interest rates. This is due to us entering, in my opinion, a deleveraging, as opposed to a recession. A recession occurs during the down-slope of a short-term debt cycle. We are entering the down-slope of a long-term debt cycle, which bears its own qualities and where interest rate manipulation by central banks has no effect on the economy or on the creditworthiness of corporations/individuals.
In a deleveraging only printing money, restructuring, wealth distribution and cutting spending works. The predominant option used by intellectually stunted central banks is printing money, (which is unsurprisingly the most commonly selected option because it is the“easiest” to execute), and printing money is always coupled with increased interest rates to prevent hyperinflation.
Note: you cannot merely limit this discussion to the Reserve Bank of Australia. The monetary and economic systems on this planet are now globalised and recessions/depressions will effect the western world as a whole.
Long answer:
The answer to your question involves understanding the difference between a recession and a deleveraging, as well as the difference between -term debt cycle and a long-term debt cycle, and the role of a Central (or “Reserve”) Bank in controlling the amount of credit in the system.
Firstly,when people refer to money, the thing they are referring to is mainly credit. Credit (i.e. debt) makes up 96% of the “money” spent in the economy. Both money and credit is used to transact. The economy is made up of the sum of the transactions that occur within it.
3 main forces drive the economy: 1. Productivity Growth 2 . Short Term Debt cycle 3. Long term debt cycle. Let's leave aside productivity growth.
In a short-term debt cycle, on is upward slope, credit becomes cheap, more people borrow, spending increases, incomes increase, asset prices increase, and (due to the higher amount of credit in the system)prices of goods, services and financial products increase. The increase in these prices is called inflation.
On the downward slope of the short-term debt cycle, when the cost of credit increases, borrowing of credit decreases, and therefore spending decreases, incomes reduce, asset prices fall, and (due to the lower amount of available credit in the system) the economy contracts. To counter this, the Central Bank reduces interest rates to make credit less expensive, and therefore to allow borrowers to afford more credit based on their income. The downward slope of a short-term debt cycle is equivalent to a recession, and usually is coupled with the reduction of interest rates (which is the point where you are coming from I think). So in the “usual” recession,interest rates are lowered to “stimulate” the economy, allowing people, businesses and governments to borrow more and spend more,creating an economic up-turn.
However,the short-term debt cycle itself is actually superimposed on top of the long-term debt cycle, in other words, the long-term debt cycle islike a large sine wave, and the short-term debt cycle is like a smaller sine wave running along the long-term debt cycle. Eventually,the short-term debt cycle reaches the crest of the long-term debt cycle... and then this is what happens...
On the upward trend of the long-term debt cycle the bottom and top of each short-term debt cycle finish with more growth than the previous cycle, and therefore with more debt. This is because, as debt increases incomes, and therefore people have more money to spend, the asset prices and the prices of goods increase to a greater height than in the previous cycle. With increased asset prices and incomes,instead of saving, people borrow more based on their increased income and valuation of their collateral (i.e. they borrow against the increased collateral and income they have). And as debts rise faster than incomes, the long-term debt cycle is created. This is overlooked by the banks,governments, the general public, companies, and the stock market, because things appear to be going great, revenue is increasing, business is expanding, asset prices increase, income and revenue is increasing. It all looks great!
Also, although interest rates fluctuate, debt levels of companies remain “manageable” based on a projection of future income, and the fact that the collateral a company has is sufficient for the bank to keep on lending and/or refinancing the company (or individual). So, even though debts have been growing, income (revenue) has been growing almost as fast to offset the debt increase. As long as incomes continue to rise, the debt burden, the ratio of debt-to-income, stays manageable. At the same time asset values soar. Individuals/companies borrow huge amounts of money to buy assets as investments causing their prices to rise even higher. These individuals/companies feel wealthy. Additionally, with the accumulation of debt, rising incomes and asset values help borrowers remain creditworthy for a long time. But, as time passes, the debt burden slowly increases, creating larger and larger debt repayments.At some point, debt repayments start growing faster than incomes forcing the borrower to cut back on their spending. The reduction of spending has a flow-on effect across the economy, which makes everyone's income decrease, and therefore their creditworthiness go down.As debt repayments continue to rise, spending drops even further, and the long-term debt cycle reverses itself. This is the long term debt peak. This is a result of the debt burdens simply becoming too big.Deleveraging occurred in the USA in the 1930s, England in the 1950s, Japan in the 1990s, GFC in 2008, Spain and Italy in the 2010s.
The rest I'll leave to Mr Dalio, founder of Bridgewater Associates:
“In a deleveraging, people cut spending, incomes fall, credit disappears,assets prices drop, banks get squeezed, the stock market crashes, social tensions rise and the whole thing starts to feed on itself the other way.
As incomes fall and debt repayments rise, borrowers get squeezed. No longer creditworthy, credit dries up and borrowers can no longer borrow enough money to make their debt repayments. Scrambling to fill this hole, borrowers are forced to sell assets. The rush to sell assets floods the market, at the same time spending falls. This is when the stock market collapses, the real estate market tanks and banks get into trouble. As asset prices drop, the value of the collateral borrowers can put up drops. This makes borrowers even less creditworthy. People feel poor. Credit rapidly disappears. Less spending › less income › less wealth › less credit › less borrowing and so on. It’s a vicious cycle. This appears similar
to a recession but the difference here is that interest rates can’t be lowered to save the day.
In a recession, lowering interest rates works to stimulate borrowing. However, in a deleveraging,lowering interest rates doesn’t work because interest rates are already low and soon hit 0% – so the stimulation ends.
Interest rates in the United States hit 0% during the deleveraging of the 1930s and again in 2008.
The difference between a recession and a deleveraging is that in a deleveraging, borrowers’ debt burden shave simply gotten too big and can’t be relieved by lowering interest rates. Lenders realize that debts have become too large to ever be fully paid back. Borrowers have lost their ability to repay and their collateral has lost value. They feel crippled by the debt –they don’t even want more! Lenders stop lending. Borrowers stop borrowing. Think of the economy as being not-creditworthy, just like an individual. So what do you do about a deleveraging? The problem is debt burdens are too high and they must come down.
There are four ways this can happen. One, people, businesses, and governments cut their spending. Two, debts are reduced through defaults and restructurings. Three, wealth is redistributed from the‘haves’ to the ‘have nots’. Four, the central bank prints new money.
These 4 ways have happened in every deleveraging in modern history.Usually, spending is cut first. As we just saw, people, businesses,banks and even governments tighten their belts and cut their spending so that they can pay down their debt. This is often referred to as austerity. When borrowers stop taking on new debts, and start paying down old debts, you might expect the debt burden to decrease.
But the opposite happens! Because spending is cut — and one man’s spending is another man’s income – it causes incomes to fall.They fall faster than debts are repaid and the debt burden actually gets worse. As we’ve seen, this cut in spending is deflationary and painful. Businesses are forced to cut costs…which means less jobs and higher unemployment. This leads to the next step: debts must be reduced!
Many borrowers find themselves unable to repay their loans — and a borrower’s debts are a lender’s assets. When borrowers don’t repay the bank, people get nervous that the bank won’t be able to repay them so they rush to withdraw their money from the bank. Banks get squeezed and people, businesses and banks default on their debts. This severe economic contraction is a depression.
Debt restructuring means lenders get paid back less or get paid back over a longer time frame or at a lower interest rate than was first agreed. Somehow a contract is broken in a way that reduces debt.Lenders would rather have a little of something than all of nothing.Even though debt disappears, debt restructuring causes income and asset values to disappear faster, so the debt burden continues to gets worse. Like cutting spending, debt reduction is also painful and deflationary. All of this impacts the central government because lower incomes and less employment means the government collects fewer taxes. At the same time it needs to increase its spending because unemployment has risen. Many
of the unemployed have inadequate savings and need financial support from the government.
Additionally,governments create stimulus plans and increase their spending to makeup for the decrease in the economy. Governments’ budget deficits explode in a deleveraging because they spend more than they earn in taxes. This is what is happening when you hear about the budget deficit on the news.
To fund their deficits, governments need to either raise taxes or borrow money. Pressure to do something to end the depression increases. Remember, most of what people thought was money was actually credit. So, when credit disappears, people don’t have enough money. People are desperate for money and you remember who can print money? The Central Bank can.
Having already lowered its interest rates to nearly 0 it’s forced to print money. Unlike cutting spending, debt reduction, and wealth redistribution, printing money is inflationary and stimulative.Inevitably, the central bank prints new money out of thin air — and uses it to buy financial assets and government bonds. It happened in the United States during the Great Depression and again in 2008, when the United States’ central bank — the Federal Reserve — printed over two trillion dollars. Other central banks around the world that could, printed a lot of money, too.
By buying financial assets with this money, it helps drive up asset prices which makes people more creditworthy. However, this only helps those who own financial assets. You see, the central bank can print money but it can only buy financial assets. The Central Government,on the other hand, can buy goods and services and put money in the hands of the people but it can’t print money. So, in order to stimulate the economy, the two must cooperate. By buying government bonds, the Central Bank essentially lends money to the government,allowing it to run a deficit and increase spending on goods and services through its stimulus programs and unemployment benefits.This increases people’s income as well as the government’s debt. However, it will lower the economy’s total debt burden. This is a very risky time. Policy makers need to balance the four ways that debt burdens come down. The deflationary ways need to balance with the inflationary ways in order to maintain stability.
As Mr Dalio rightly points out, lowering interest rates is simply not possible. In a deleveraging only printing money, restructuring, wealth distribution and cutting spending works.
