The destruction of the world economy by the Central Banks

For years, we have been warning about dire consequences if central banks continue to meddle in the economy and financial markets. In December 2013, we wrote

There is a serious possibility that the measures taken by the central banks have already created a situation in which their actions increase rather than decrease financial instability. This is due to the fact that, if the actual price of an asset does not meet its market–based value, the true level of risk is not properly revealed.

During the “Coronavirus rescue” by the major central banks from March through June of this year, we essentially ran down the clock. No viable paths remain to escape the vicious feedback loop between central banks and financial markets — at least without serious repercussions.

Over the years, central banks have created conditions where prices in capital markets — and by implication, the resulting capital allocation structure — have become distorted to a previously unimaginable degree.

This has resulted in three extremely troublesome fragilities at the heart of the world economy. First, it has led to ‘yield hunting’ among investors, who are forced to seek higher yields from riskier financial products.

Secondly, it has led to a permanent central bank intervention in the financial markets, because without it a crash would surely occur.

Thirdly — and this is something that has received much too little attention — the massive capital misallocations due to unnaturally low interest rates have ‘hollowed-out’ vast sectors of the global economy.

We have been focusing on the fragility of the financial markets frequently lately, so this time we will concentrate on the capital misallocation issue instead, though the two are inherently linked.

The driving force of the economy

In March 2019 we devoted the entirety of the Q-Review to explain why global economic growth has sputtered since 2009.

We explored, extensively, the concept of creative destruction, which describes the process by which capitalist economies evolve and grow over time. In essence, creative destruction enables the flow of technical innovations into the economy through the destruction of old and inefficient production methods and enterprises, and the emergence of new, more productive firms.

Moreover, we wrote that

The risk-and-reward relationship, that is, the gains and failures of the private sector drive economic progress. The first accumulates income and capital, while the second uncovers sustainable businesses, setting the stage for the creative destruction.

In essence, this is what a capitalist economy is all about. The accumulation of capital is required to provide the funding for sustainable businesses, which provide employment, personal income and tax revenues.

Price discovery in the modern capital markets is essential to accurately evaluate the risk-and-reward relationship of both real economic investments as well as those of financial assets. Price discovery thus guides the efficient allocation of capital to its most profitable employment, based on the information gathered by millions of investors. This idea is part of the bedrock of capitalist theory.

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Source: Tuomas Malinen | GnS Economics