Fake it Till You Make It…or Break it: The Real Economy is Collapsing

Dear Reader,

In 1998, Enron set up a command centre for its Enron Energy Services (EES) division in time to showcase it during their annual conference with Wall Street analysts.

Enron had high hopes for EES, which had the goal of selling energy to businesses directly.

What analysts saw during their visit, was sure to impress. A busy floor, lots of staff and phones ringing off the hook.

But the reality was quite different.

As people found out a few years later, the centre wasn’t up and running at the time. Enron had spent hundreds of thousands to kit the area with TVs and computers. They brought staff in from other floors and scheduled calls during the conference to make it look like a busy trading floor.

They even held a rehearsal the day before.

And it did the trick…for a while. We all know how Enron’s story ended.

Enron wasn’t the first facade built to hide what’s really underneath. It surely won’t be the last either.

And speaking of facades…

The US added an extra 2.4 million to their unemployment ranks this week. This makes it a total of 39 million in the last nine weeks. The latest US Industrial Production Index dropped by 11.2% in April.

Famous economic forecaster Harry Dent warns of a ‘crash of a lifetime; coming in 2020… Get the Free Report Now.

Central bank stimulus is propping up markets

While the real economy is collapsing, the S&P 500 is trading at the same levels as this time last year. What’s propping up markets is not earnings, but central bank stimulus.

In an interview this week, US Fed chairman Jerome Powell spoke with 60 Minutes.

Fair to say you simply flooded the system with money?’ the interviewer asked.

Yes. We did. That’s another way to think about it. We did. We print it digitally. So as a central bank, we have the ability to create money digitally. And we do that by buying Treasury Bills or bonds for other government guaranteed securities. And that actually increases the money supply. We also print actual currency and we distribute that through the Federal Reserve banks.

Note that all this money is supposed to be paid back at some point. Will that ‘flood’ of money be used smartly? Will it filter down to the population?

You can watch the full interview here.

Anyway, to my point. Notice how many times he mentions the word ‘confidence’? Because confidence is quite crucial to the economy. When people are confident they spend.

Our whole system is based on spending. Here in Australia, for example, consumer spending makes up 60% of the economy.

In times of fear and uncertainty though, people tend to sit on money, save more and spend less.

Central banks can flood the system with money, but if people save it instead of spending it, it won’t do much for the economy.

How do you get people to spend?

Well, one way is to make spending and debt more attractive…it’s something that central banks have been doing for years by keeping interest rates at record lows.

In fact, the COVID-19 crisis caught many of the developed countries with really low interest rates. If the economy was doing so well before COVID-19 then why were interest rates still so low?

Another way to get people to spend is to make savings less attractive. It’s something you can achieve with negative interest rates.

Negative interest rates were deemed impossible until a few years ago. Instead of the bank paying you interest to use your money, the saver pays for the benefit of having a deposit. Keeping money in the bank loses you money.

So far, Powell is denying the Fed is looking at implementing interest rates. The same goes for the Reserve Bank of Australia, which has said it will be ‘extraordinarily unlikely’.

Of course, they are free to change their mind at any time…much like the Bank of England did this week.

From the Financial Times:

The Bank of England is eyeing the introduction of negative interest rates for the first time in its 324-year history in a move to help stimulate an economic recovery.

Andrew Bailey, the BoE governor, confirmed negative rates were under “active review”, under questioning from MPs on a day when bond investors accepted that they would need to pay to lend money to the UK government. The interest rate in a gilts auction fell below zero for the first time.

Pushing official short-term interest rates into negative territory would be a powerful signal from the BoE that companies should spend rather than face charges to hold money on deposit in banks.

The new position is a U-turn from just a week ago when Mr Bailey said the BoE was not “planning or contemplating” negative rates amid the coronavirus crisis.

He told the House of Commons Treasury select committee on Wednesday that he had “changed his position a bit”.

The problem with negative interest rates is that as long as there is an alternative out there, they won’t work.

Alternatives are gaining interest…

And there is definitely an alternative: cash.

If interest rates go below zero, people will start stashing cash at home to avoid losing money.

It’s a ‘problem’ the International Monetary Fund (IMF) tried to solve last year by providing some solutions in a blog post titled ‘Cashing in: How to make negative interest rates work’.

One of the solutions they gave was to divide the money supply in two: cash and e-money.

E-money is only used electronically and, as they offered in their example, it pays -3% a year in interest. Cash use is still allowed but you need to exchange it for e-money anytime you want to deposit it into your bank account.

The cost to convert it (as in their example) is 3%. So, for every $1 you get $0.97.

The same concept applies anytime you want to buy something in cash at a store. So, there is no advantage to holding on to your cash.

As they said:

While a dual currency system challenges our preconceptions about money, countries could implement the idea with relatively small changes to central bank operating frameworks. In comparison to alternative proposals, it would have the advantage of completely freeing monetary policy from the zero lower bound.

The other solution offered was to get rid of cash altogether which, a year ago would have faced quite a backlash. Now, with a killer virus on the lose…well, the idea might not be met with much resistance.

The real economy is collapsing. Central banks are flooding the system with money, but this is taking us further down the rabbit hole.

Will we make it…or break the system?

It’s not surprising that alternatives like gold and bitcoin are gaining interest.

Stay tuned for more.


Selva Freigedo
Editor, The Rum Rebellion

PS: FREE ‘Crisis Money Guide’ explains how a currency crisis could suddenly unfold and how to survive it. Click here to claim your copy now.

Selva Freigedo is a research analyst for The Rum Rebellion.

Born in Argentina, her passion for economic analysis started at a young age. Her father was an economist for the Argentinean governments and the family used to discuss politics and economics at the dinner table.

Argentina is a country with an unusual economic history. Growing up there gave Selva first-hand experience on different economic phenomena such as hyperinflation, devaluation and debt default.

Selva has also lived in Brazil, Spain and the USA.

Back in 2000 she was living in the US as the dot com bubble popped…
And in 2008 she was in Spain as the property market exploded and then collapsed…

She has seen first-hand what happens when bubbles burst.

Selva joined Fat Tail Investment Research’s team in 2016, as an analyst. She now writes from her vantage point in Australia, where she settled in 2015.

The Rum Rebellion