January 6, 2012

Top Three Central Banks Account For Up To 25% Of Developed World GDP

For anyone who still hasn't grasped the magnitude of the central planning intervention over the past four years, the following two charts should explain it all rather effectively. As the bottom chart shows, currently the central banks of the top three developed world entities: the Eurozone, the US and Japan have balance sheets that amount to roughly $8 trillion. This is more than double the combined total notional in 2007. More importantly, these banks assets (and by implication liabilities, as virtually none of them have any notable capital or equity) combined represent a whopping 25% of their host GDP, which just so happen are virtually all the countries that form the Developed world (with the exception of the UK). Which allows us to conclude several things. First, the rapid expansion in balance sheets was conducted primarily to monetize various assets, in the process lifting stock markets, but just as importantly, to find a natural buyer of sovereign paper (in the case of the Fed) and/or guarantee and backstop the existence of banks which could then in turn purchase sovereign debt on their own balance sheet (monetization once removed coupled with outright sterilized asset purchases as is the case of the ECB). And in this day and age of failed economic experiments when a dollar of debt buys just less than a dollar of GDP (there is a reason why the 100% debt/GDP barrier is so informative), it also means that central banks now implicitly account for up to 25% of developed world GDP!

What does this mean? It means that nearly $8 trillion in world economic growth is artificial and exists only courtesy of central bank intervention - if one is looking for the reason why there is no mean reversion to a more stable period of time, there's your answer. It also means that central banks will never unwind their "assets", either actively, or passively, by letting them mature, as doing so would effectively mean an accelerated return to a non pro forma status quo, one in which global GDP suddenly finds itself $8 trillion less. It also means that in this age of ongoing consumer and corporate deleveraging, central banks will have no choice but to continue monetizing not to generate incremental growth, but to offset debt destruction elsewhere. And of course, in order to sustain global GDP growth of ~3%, they will have to print even more, in other words, accrue more liabilities (excess reserves) which of course would be funded by monetizing even more paper issuance (which Congress would be delighted to oblige with). Which is why we find the announcement by the Fed that it will notify in advance what the Fed Funds rate will be, to be beyond humorous: after all in an environment of active monetization, the only possible interest rate is zero (although the ECB tried a brief experiment otherwise, when it held higher rates than 1% to combat inflation even as it tried, unsuccessfully, to create a debt monetizing off balance sheet vehicle- the EFSF and the ESM).

Unfortunately, the worst news is that for everyone who feels that the global economy is fake - you are right: up to 25% of all economic growth is what in a different day and age would have been called "one-time and non-recurring" - unfortunately, since now this is the trump card on which the entire western model depends, "one-time and non-recurring" is better known as "constant and endless."

Our advice to anyone in the trading and investing business who has just had enough of central planning, and its ridiculous impact on capital markets which involves but is not limited to reacting to various disjointed headlines constantly, instead of trading based on a proactive, fundamentally-driven strategy is: find a new job. The new normal may be the "new paranormal", but more than anything it is the new centranormal. Because from now until the inevitable collapse of the financial system in its current form, nothing will change.

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