The Age Of Debt And Monetary Destruction

Authored by Daniel Lacalle,

If you want to really understand the current monetary system and the risks and opportunities it creates, you must read “The Age of Debt Bubbles.” This is a comprehensive, informed, and thorough analysis of the current global monetary system.

Debt bloats the global economy. Spending and debt, rather than savings and prudent investment, form the foundation of economic development. This debt-based system, where sovereign debt is allegedly the safest asset and governments continue to stretch their solvency ratios, is constantly generating boom and bust cycles. Through a meticulous examination of historical data and trends, this book analyses the risks posed by the ever-expanding debt bubbles.

The book explains that debt has become a pervasive and inescapable feature of modern economies. The relentless pursuit of growth and profit with little equity involved has driven individuals, corporations, and governments to take on increasingly larger amounts of risk through indebtedness in exchange for lower returns, creating a fragile house of cards that is the root of all financial crises.

The Era of Increasing Debt Bubbles and Economic Instability: “An In-depth Analysis of Debt Crises, Asset Bubbles, and the Role of Monetary Policy” offers a thorough and exhaustive exploration of contemporary monetary policy, debt-fueled bubbles, and the economic consequences they entail.

There are two main sections in the book:

The first part delves deeply into elucidating the intricate process of money creation within contemporary economies while also scrutinising the formation of debt bubbles. Here are some key points to consider:

Banks create new money when making loans, expanding both sides of their balance sheet. Governments create new money through spending and borrowing. Banks need some capital to lend to the private economy. None is required to lend to money-printing governments. Even economists often misunderstand this process. Additionally, central bank reserves are not a constraint on bank lending; they are supplied on demand.

This process of constant monetary expansion to justify the accumulation of risk is often referred to as “liquidity injections,” as if it were a much-needed blood transfusion, when most of the time it simply disguises rising debt and risks built into the financial system. The current monetary system disguises its tendency to create boom-bust cycles with newly created currency.

This constant process of credit expansion can lead to malinvestment and economic distortions. Companies take increasing levels of debt to invest in businesses with fragile fundamentals, house prices rise well above affordability, credit card borrowing reaches all-time highs despite rising inflation and weaker real wage growth, and equity and bond valuations soar despite poor economic fundamentals… All these are manifestations of the risk of malinvestment and debt accumulation.

Part two features chapters from senior policymakers offering perspectives on debt bubbles and modern central banking.

Contributors include William White (former BIS official), Barbara Kolm (Austrian central bank VP), Lord Syed Kamall (former MEP), and Miguel Fernandez Ordoñez (former Bank of Spain Governor). Some of these contributors see the monetary system from a Keynesian perspective, giving the reader a balanced approach and different perspectives.

This essential work highlights how most textbooks and economists misunderstand the creation of money in modern economies. The book correctly criticises central bank policies, which seem more focused on perpetuating and disguising bubbles than preventing them. The manipulation of interest rates is one of the most dangerous factors. Central banks cut interest rates to encourage credit growth, and this always leads to distortions in the economy. Furthermore, when monetary policy creates inflation, policymakers increase rates, hurting the last recipients of money more severely.

Money creation is never neutral. It always disproportionately benefits the first recipient of new money, governments in particular, and negatively impacts the last recipients, real wages, and deposit savings. As such, the current monetary system is designed to penalise the most prudent savers and erode the purchasing power of the currency while rewarding excessive risk-taking and government fiscal irresponsibility.

In periods of monetary expansion, the size of government in the economy rises as adding debt is rewarded and regulation forces banks to consider government debt as a zero-risk asset. However, in periods of monetary contraction, the size of government in the economy also increases because almost the entire burden of interest rate hikes and liquidity contraction falls on the shoulders of families and small businesses.

The authors of this seminal work propose that the monetary policy framework of advanced countries requires fundamental reforms. They advocate for a system that shifts from an endless increase in reserves to a system of scarce reserves, akin to the gold standard. This would reduce central banks’ footprint in the economy and limit their effects on resource allocation. It is also crucial to limit the central banks’ links with government indebtedness to maintain independence, also reducing central bank balance sheets to maximise their ability to expand when truly needed. The authors also suggest that market forces should determine interest rates more than central bank policy, as malinvestment and asset bubbles primarily stem from artificially low interest rates.

“The Age of Debt Bubbles” is an essential contribution to the debate on monetary policy and financial stability. It challenges conventional wisdom and offers alternative perspectives on issues that affect all of us.

As Hayek said:

“the past instability of the market economy is the consequence of the exclusion of the most important regulator of the market mechanism, money, from itself being regulated by the market process.”.

This book is particularly timely because citizens are suffering persistent inflation after unprecedented central bank interventions, leading to all-time high asset prices but weaker real wage growth. If you want to understand money and why it matters to you, this is an essential read.

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The Age of Debt Bubbles: An Analysis of Debt Crises, Asset Bubbles and Monetary Policy (Professional Practice in Governance and Public Organizations) Springer-Verlag GmbH, 2024, is available in all good bookstores and online shops.