The idea that we are headed towards an economic collapse used to a fringe concept, but by mid-2020 it was no longer uncommon to see mainstream outlets talking about the inevitability of a global depression, or how a sovereign debt crisis and ultimately a monetary crisis are on the horizon. At this point these are obvious conclusions to anyone who has done even a little research, however very few pundits are looking at the big picture.
Though COVID-19 will be blamed for the economic woes of the 2020s, in reality it will merely serve as a catalyst. For over a decade following the Global Financial Crisis (GFC) central bank interventions inflated the largest market bubble in history. When this bubble pops it will have knock on effects that extend far beyond the price of stocks and bonds.
Modern money is created through a process called fractional reserve banking. In simple terms, banks are allowed to loan out money that they don’t have. When this loan is deposited into the borrower’s account new money is created. This is why central bank manipulation of interest rates has such a significant effect on economies. When interest rates are low loans are more attractive and more debt is issued. This leads to an expansion of the monetary supply.
Quantitative Easing enables central banks to create new money in a more direct way: by purchasing financial assets (primarily mortgage backed securities and government bonds). Like fractional reserve banking, the money used to purchase these assets is literally typed into existence.
The first round of QE started in 2009 after the housing bubble collapsed. This was followed by two more rounds that continued into 2014. 2020 brought us round four (aka QE Infinity). In this round the Fed extended its purchases to include corporate debt and etfs. In one month they purchased more assets than they had during the entire first year following the 2009 crisis (see chart below). By the end of May they had over 7 trillion dollars worth sitting on their books. This new money fueled the most powerful stock rally in history.
To put this in perspective, one of the companies that benefited the most from this rally (Tesla) would have have to sell cars for 1,600 years to earn earn the equivalent of what investors have poured into it. As the disconnect between market prices and the real economy has grown bigger more and more experts have voiced their concerns about what comes next.
The elephant in the room here is that when this current bubble pops central banks will be out of ammunition. The tools that they have used to inflate bubble after bubble in recent decades will have little or no effect. This is where a monetary crisis enters the picture. In such a scenario the dollar’s world reserve currency status will be lost, initiating a cascade of secondary consequences.