Global solutions for global problems are a dangerous illusion

The Bank for International Settlements (BIS), also known as the bank of central banks, was one of the few institutions that issued warnings before the onset of the global crisis in 2007.

The most powerful voice was that of William White, the chief-economist of BIS between 1995 - 2008. Unfortunately, White was "the man that nobody would listen to", like the German magazine Der Spiegel wrote in the summer of 2009, which also said that "the central bankers preferred to listen to his great rival, Alan Greenspan, instead".

Stephen Cecchetti, the successor of White as the chief economist of the BIS, recently evaluated his activity over the last five years at the annual conference of the bank of central banks, in a presentation called "Five years in the tower". Cecchetti probably referred to the "ivory tower" of theorists, who are increasingly irrelevant before the relentless assault of economic reality. It is precisely this irrelevance which has stopped him from wanting another term as chief-economist of the BIS.

Speaking of moral hazard, which is "worse than thought", Stephen Cecchetti also said that "the nature and size of the risks assumed by the financial institutions are greater than we thought", because "the fundamental issue is the divergence between the interests of banks and those of society".

The source of this conflict of interest comes from the limited liability of owners and from the increase of the leverage, which encourages risky investments. "Banks knew that by increasing their own size, they would become too big to fail", the chief economist of the BIS said.

Jaime Caruana, whose term as General Manager of the Bank of International Settlements was extended, said, during the same annual conference of the BIS, "that the relaxation of financial conditions has a limited effect on the revitalization of the economic growth, when the balance sheets are deteriorated and the resources are misallocated on a large scale".

Caruana referred to the balance sheets of households as well as of non-financial companies, which are faced with "very high debts". Under these circumstances, "it doesn't matter how attractive the authorities may try to make the granting or taking on of new loans", because the "households and companies are focused on fixing their balance sheets", the executive director of the BIS said.

What looks to be an accurate diagnostic of the two officials unfortunately comes too late, and the proposed solutions are wrong.

We do not find this opinion only among the supporters of the Austrian school of economics, but is increasingly appearing among the researchers that study the dynamic of complex systems.

Didier Sornette, a professor at the Federal Institute of Technology in Zürich and specialist in geophysics and the dynamic of complex systems, wrote about "the illusion of the perpetual monetary machine" in an article published in October 2012. In the opinion of professor Sornette, there is strong evidence that shows that "from the first half of the 80s, consumption has been financed through increasingly lower savings, compensated by the accelerated growth of financial profits, of the price of homes and by the explosive increase of debts".

The AMECO database of the European Commission provides evidence for his statements. In the case of the economy of the United States, the weight of private consumption in the GDP has begun increasing at accelerated pace (see chart 1), amid a drop in the weight of salary income, which led to a negative difference of over 10% of the GDP at the end of 2008.

For the 15 states which made up the European Union prior to its expansion in 2004, the creation of the ECU in 1995 (author's note: the European Monetary Union, the precursor of the Euro) gave the signal of a convergence which had extremely negative effects between salaries and consumption (see chart 2).

Saving has disappeared from the European economic landscape, and together with it, the mechanism of a sustainable development of capital also disappeared, which led to lower productivity.

In this context, professor Sornette asks a simple question: "Is it sustainable for an economy that in real terms grows with 2 - 3% per annum to ensure a return of 10 - 15%, given the investment opportunities available to all investors?"

The answer is negative of course, but the reality has been concealed for a long time by the ultrarelaxed policies of the central banks, which have opened up the floodgates of an unprecedented monetary flood on the global economy.

The imposition of the supremacy of the financial markets, through increasingly sophisticated "innovations" has allowed the reinforcement of the illusion that "true wealth comes from monetary creation", as written by professor Sornette, an illusion which is still dominant at the authorities' level and is preventing the appearance of "new fundamental lines of thinking".

The solutions proposed by Sornette start from "emphasizing simplicity instead of complexity". Unfortunately, that kind of alternatives aren't taken into consideration by the authorities, as the French teacher notes the "current trend of higher regulation complexity of regulations", which "is not a good sign".

So then, why is such complexity resorted to? Because this creates the impression of the total involvement of the authorities in dealing with the crisis, while also creating a framework that would hide the just as complete lack of taking responsibility.

"The illusory belief that creating riches out of nothing is based on the debt and the mechanisms which fuel the expansion of lending", Sornette also writes, as this belief is possible due to the "deregulation of the financial system and of the fuel provided by the quantitative easing policies".

Faced with the ineffectiveness of the monetary and fiscal policies, the confidence in this mechanism of perpetual welfare has vanished, and investment decisions are increasingly focusing on the preservation of capital than on its return. The emphasis is now on what is really necessary for long term economic development, as shown by Sornette, which exemplifies the new trend, reminding of the acquisitions of Romanian forests by investment fund of Harvard University.

Unfortunately, simple solutions have no traction with the central banks. Stephen Cecchetti is convinced that "the global issues can only be solved with global solutions", forgetting that the global economy is a complex system, which in turn is made up of just as complex subsystems. In this context, "the global solutions" only increase its fragility to shocks similar to that of 2007, especially amid the persistence of the extremely high leverage ratio, which no longer have any coverage in the real economy.

The chief-economist of the BIS also considers that "the discipline imposed by the markets is not enough", and he demonstrates his claim through the conditions in the banking system: "Banks that found ways to avoid the capital requirements effectively had no capital reserves".

But this is not, in any way, evidence of the failure of the markets, but rather of the major flaws of the regulatory framework, which has allowed banks to move to the unchecked lending expansion, without fear of the consequences. Because central banks were and are ready to "save" banks indiscriminately, regardless of whether it was about solvency or liquidity issues.

The fruitful "collaboration" between the fiscal and monetary authorities allowed the doubling of the balance sheets compared to 2007, to up to 20 trillion dollars, and the increase of the public debt, during the same interval, by about 23 trillion dollars, according to data from the BIS.

Without notable results when it comes to economic restructuring, the monetary explosion of the last few years confirms the fact that "we can't deal with problems using the same line of thought used when we create them", like Albert Einstein said.

Even if "the growth financed by credit has concealed the downward trend of productivity and the large scale distortion of resources", according to the statements of Jaime Caruana, and "the growth of lending will not reinforce the financial sector nor will it allocate the resources needed for the turnaround of the economies for using real growth", the authorities do not want to deviate from the boosting of lending using any available means.

The true solution to the current crisis is not represented by the increase in the degree of centralization and coordination of the global economy, but the decentralization and economic cooperation. Also, the new economic global structure can not be developed using the monetary foundations of the last four decades, a system characterized by the pyramid scheme of the paper money built around the dollar.

Ignoring the sample of Einstein's wisdom quoted above, the authorities seem to want to confirm another one of his sayings: "Insanity is doing the same thing over and over again and expecting different results".

But now, nobody has patience anymore, not the markets and not the citizens, to wait for the predictable and unavoidable results of the "insanity".