During the last three decades there has been a massive transfer of wealth from debtors to creditors with the blessings of the world’s Central Banks at the forefront, those of the developed kind, in the pursuit of zero or inflation intolerance and continuously high real interest rates.
This has been so successful that, in the most part, for the last two decades the world has experienced unfettered growth, low inflation and as a consequence of collapsing inflationary expectations, ever falling long term interest rates. Windfall profits to creditors.
In turn those low rates and the anticipation of unequivocal sustainable long term growth further induced the financial world at large (creditors) to open the lending spigots and provide cheap credit to sovereigns all along the lending chain down to households, at unprecedented levels.
As in all mature expansions, particularly those which have been extended with the ever supportive Central Banks, this culminated in a financial frenzy where prudent regulatory mechanisms, where they existed, were ignored on the unfounded premise that markets know better, on some occasions coercively, in favor of ever expanding balance sheets reflecting ever questionable assets.
Like a pack of cards sitting on frail foundations, the stack came tumbling down as participants began to doubt the strength of their investment convictions. The chain effect didn’t take long to ripple from the
US financial system to the peripheral sovereigns of Europe. Most affected were those whose debts were directed towards private consumption and were not invested for the furtherance in the productive process.
In an attempt to solve the problem created in large part by their own actions, creditors continued to impose strict adherence to their modus operandi as a means of restructuring debtor’s balance sheets and ultimately avoid insolvency.
However, this adjustment process was too austere particularly to those same debtors it was supposed to help as their economic well being was reliant on these same transfers of debt. The resultant effect was to bring debtors one step closer or to bankruptcy per se. Furthermore, the automatic safety net of too big to fail contributed to the totally miscued process of equitably sharing the consequences of what should have been their professional risk taking enterprise. The burden fell once again on the shoulders of the ever supportive debtors. Windfall profits to creditors.
In a globalised economy with all factors of production and consumption interacting this was bound to come to an end. And it has. As debtors became insolvent en masse the balance sheets of creditors began to suffer and without the help of debtors had no alternative but to commence a process that would ultimately lead to a market imposed transfer of wealth to debtors.
It is only once the world economy begins to rebalance the scales in favor of debtors, will it be able to continue along the path to prosperity. This however will require massive addition of liquidity by all participating Central Banks to the extent that not only should they totally abandon their aversion to non existant inflation but embrace and welcome the pursuit of increased inflationary expectations. Only then will the world financial system begin to strengthen its footing.