The European Central Bank (ECB) is planning to pump 1.1 trillion euro’s into the banking system to fend off price deflation and revive economic activity. The ECB president and his executive board are planning to spend 60 billion euro’s a month from March 2015 to September 2016.
Most experts hold that the ECB must start acting aggressively against the danger of deflation. The yearly rate of growth of the consumer price index (CPI) fell to minus 0.2% in December last year from 0.3% in November and 0.8% in December 2013.
Many commentators are of the view that the ECB should initiate an aggressive phase of monetary pumping along the lines of the US central bank. Moreover the balance sheet of the ECB has in fact been shrinking. On this the yearly rate of growth of the ECB balance sheet stood at minus 2.1% in January against minus 8.5% in December. Note that in January last year the yearly rate of growth stood at minus 24.4%.
Why is a declining rate of inflation bad for economic growth? According to the popular way of thinking declining price inflation sets in motion declining inflation expectations. This, so it is held, is likely to cause consumers to postpone their buying at present and that in turn is likely to undermine the pace of economic growth.
In order to maintain their lives and well being individuals must buy present goods and services, so from this perspective a fall in prices as such is not going to curtail consumer outlays. Furthermore, a fall in the growth momentum of prices is always good for the economy.
An expansion of real wealth for a given stock of money is going to manifest in a decline in prices (remember a price is the amount of money per unit of real stuff), so why should this be regarded as bad for the economy?
After all, what we have here is an expansion of real wealth. A fall in prices implies a rise in the purchasing power of money, and this in turn means that many more individuals can now benefit from the expansion in real wealth.
Now, if we observe a decline in prices on account of an economic bust, which eliminates various non-productive bubble activities, why is this bad for the economy?
The liquidation of non-productive bubble activities – which is associated with a decline in the growth momentum of prices of various goods previously supported by non-productive activities – is good news for wealth generation.
The liquidation of bubble activities implies that less real wealth is going to be diverted from wealth generators. Consequently, this will enable them to lift the pace of wealth generation. (With more wealth at their disposal they will be able to generate more wealth).
So as one can see a fall in price momentum is always good news for the economy since it reflects an expansion or a potential expansion in real wealth.
Hence a policy aimed at reversing a fall in the growth momentum of prices is going to undermine and not strengthen economic growth.
We hold that the various government measures of economic activity reflect monetary pumping and have nothing to do with true economic growth.
An increase in monetary pumping may set in motion a stronger pace of growth in an economic measure such as gross domestic product. This stronger growth however, should be regarded as a strengthening in the pace of economic impoverishment.
It is not possible to produce genuine economic growth by means of monetary pumping and an artificial lowering of interest rates. If this could have been done by now world poverty would have been erased.
Summary and conclusion
The European Central Bank (ECB) is planning to pump 1.1 trillion euro’s into the banking system to fend off price deflation and revive economic activity in the Euro-zone. Most experts are supportive of the ECB’s plan. We question the whole logic of the monetary pumping.
A fall in the growth momentum of prices either on account of real wealth expansion or on account of the demise of bubble activities is always good news for wealth producers.
Hence any policy that is aimed at preventing a fall in prices is only likely to strengthen bubble activities and undermine the process of wealth generation.
As inflation rates continue to fall across the Eurozone one might expect Austrian economists to rejoice. After all, inflation reduces our purchasing power and acts as a hidden form of taxation. Failure to control inflation caused some of the greatest social and political disturbances of the twentieth century, and attempts to centrally plan the monetary system are destined to failure. George Selgin’s “Less than Zero” is the seminal account of how deflation can be beneficial, and why central banks should be willing to tolerate it. However it also provides a useful, and highly relevant distinction between “good” and “bad” deflation. The underlying point that needs to be expressed is that not all deflation is ghastly. Indeed the readily available examples of falling prices – such as the Great Depression – are not representative. Allowing a fear of deflation to prevent deflation in any circumstance will commit monetary policy to steady and suboptimally high inflation. The Great Moderation is perhaps the best example of the harm that can be done when we fail to allow increases in productivity to manifest themselves in falling prices. But the relevant point is whether this is the situation we find ourselves in right now.
Austrians tended to be ahead of the expectations revolution therefore to some extent it isn’t inflation or deflation per se that matters, but how it ties into expectations. If the inflation rate is falling, and especially if it’s falling more than expected, we have problems. If inflation is 2% a year, but this is anticipated, then the costs of inflation are reasonably low. If it’s -2% a year, and anticipated, ditto. The problems occur if we transition from one to the other.
Inflation in the Eurozone is currently 0.3%, and the rate has been steadily falling since early 2012. There’s two main reasons why we may expect falling pressure on prices. One is that the underlying capacity of the economy has increased. Positive productivity shocks will increase the potential growth rate, make it easier to produce output for a given amount of inputs, and make things cheaper. In terms of Dynamic AD-AS analysis, it constitutes an increase in the Solow curve. This is good deflation. But it also implies that real GDP will be rising.
Alternatively, prices might be falling because of a reduction in what Keynesians call “aggregate demand”, Monetarists call “nominal income”, or what Austrians call “the total income stream”. These are all various ways to refer to total spending. This could fall as a result of a monetary contraction, or an increase in the demand for money. It’s important to realise that whilst central banks are the prime culprits of the former, they are also a key instigator of the latter. Keynesians might blame it on “animal spirits”, but we can also think of this as “regime uncertainty”. These are two ways to treat confidence as a meaningful concept, and something that can be negatively affected by central bank policy.
Many commentators attribute low inflation to low oil prices. On the surface this seems like a positive supply shock and hence the reason for low prices is a good one. However the reason oil prices are low is because of increases in supply and decreases in demand. The former is a result of IS getting the keys to the pumps. The latter is due to a slowdown in China. Neither of these bode well for the global economy. Both of them have reduced confidence.
We can see this negative AD shock in the data. With GDP growth of just 0.7% this means that total spending is just 1%. This is significantly lower than where we would like it to be in a world with a greater rate of achievable growth and a 2% inflation target.
So what needs to be done? Austrians are loathe to advocate monetary activism and for good reason. But the goal of monetary policy is not inactivism, but neutrality. The issue comes down to the costs of adjustment. If aggregate demand remains at 1% then people will adjust their expectations, prices will adjust, and output will return to normal. During the Great Depression Hayek advocated this path, even though he recognised that prices take time to adjust, and whilst they do so unemployment would rise. His reasoning was that increasing the load on price adjustments will increase their flexibility. In a time of chronic wage and price inflexibility it was a moment to bust the unions. However he later came round to the idea that those costs were too high. The collateral damage of using a downturn to put more emphasis on nominal wage adjustments was unfair. For the mass unemployed, nominal wage rigidities isn’t their fault. So instead of placing the burden on wage adjustments, central banks have the option of maintaining a certain level of total income. This avoids the necessity of a nominal wage adjustment, in part because inflation allows real wages to adjust.
The fact that we are starting to see inflation expectations fall implies that this is only the beginning of an economic adjustment. If the total income stream continues to grow at a less than expected (and possibly even a negative) rate then we will have plenty new problems to worry about. This isn’t just the economy responding to the pre 2007 boom. This is the economy responding to fresh problems being introduced by central bank incompetence.
The difficulty for the ECB – and possibly the explanation for why things are so much worse in the Eurozone than in the US or UK – is that they don’t have the same tools available. But let’s leave a debate over tools for another time. The bottom line is that the ECB should be striving to give clear guidance and generate credibility for pursuing a steady increase in a target nominal variable. Monetary policy cannot generate wealth – all it can do is buy time for governments to sort out their competitiveness and improve their public finances. The fact that they aren’t making use of the breathing room provided by central banks is their fault. But monetary policy can destroy wealth, and a failure to maintain a steady total income stream is contributing to those competitiveness and public finance problems. I would love to believe that this impending deflation is the good sort, or that Eurozone labour markets were flexible enough to allow prices to do all the heavy lifting. But I fear that we’re seeing an impending catastrophe, and the ECB needs to take bolder action to prevent making things even worse.
First, he gave an unexpectedly dovish speech at the Jackson Hole conference, rather ungallantly upstaging the host, Ms Yellen, who was widely anticipated to be the most noteworthy speaker at the gathering (talking about the labor market, her favorite subject). Having thus single-handedly and without apparent provocation raised expectations for more “stimulus” at last week’s ECB meeting, he then even exceeded those expectations with another round of rate-cuts and confirmation of QE in form of central bank purchases of asset-backed securities.
These events are significant not because they are going to finally kick-start the Eurozone economy (they won’t) but because 1) they look rushed, and panicky, and 2) they must clearly alienate the Germans. The ideological rift that runs through the European Union is wide and deep, and increasingly rips the central bank apart. And the Germans are losing that battle.
As to 1), it was just three months ago that the ECB cut rates and made headlines by being the first major central bank to take a policy rate below zero. Whatever your view is on the unfolding new Eurozone recession and the apparent need for more action (more about this in a minute), the additional 0.1 percent rate reduction will hardly make a massive difference. Yet, implementing such minor rate cuts in fairly short succession looks nervous and anxious, or even headless. This hardly instils confidence.
And regarding the “unconventional” measures so vehemently requested by the economic commentariat, well, the “targeted liquidity injections” that are supposed to direct freshly printed ECB-money to cash-starved corporations, and that were announced in June as well, have not even been implemented yet. Apparently, and not entirely unreasonably, the ECB wanted to wait for the outcome of their “bank asset quality review”. So now, before these measures are even started, let alone their impact could even be assessed, additional measures are being announced. The asset purchases do not come as a complete surprise either. It was known that asset management giant BlackRock had already been hired to help the ECB prepare such a program. Maybe the process has now been accelerated.
This is Eurozone QE
This is, of course, quantitative easing (QE). Many commentators stated that the ECB shied away from full-fledged QE. This view implies that only buying sovereign debt can properly be called QE. This does not make sense. The Fed, as part of its first round of QE in 2008, also bought mortgage-backed securities only. There were no sovereign bonds in its first QE program, and everybody still called it QE. Mortgage-backed securities are, of course, a form of asset-backed security, and the ECB announced purchases of asset-backed securities at the meeting. This is QE, period. The simple fact is that the ECB expands its balance sheet by purchasing selected assets and creating additional bank reserves (for which banks will now pay the ECB a 0.2 percent p.a. “fee”).
As to 2), not only will the ECB decisions have upset the Germans (the Bundesbank’s Mr. Weidmann duly objected but was outvoted) but so will have Mr. Draghi’s new rhetoric. In Jackson Hole he used the F-word, as in “flexibility”, meaning fiscal flexibility, or more fiscal leeway for the big deficit countries. By doing so he adopted the language of the Italian and French governments, whenever they demand to be given more time for structural reform and fiscal consolidation. The German government does not like to hear this (apparently, Merkel and Schäuble both phoned Draghi after Jackson Hole and complained.)
The German strategy has been to keep the pressure on reform-resistant deficit-countries, and on France and Italy in particular, and to not allow them to shift the burden of adjustment to the ECB. Draghi has now undermined the German strategy.
The Germans fear, not quite unjustifiably, that some countries always want more time and will never implement reform. In contrast to those countries that had their backs to the wall in the crisis and had little choice but to change course in some respect, such as Greece, Ireland, and Spain, France and Italy have so far done zilch on the structural reform front. France’s competitiveness has declined ever since it adopted the 35-hour workweek in 2000 but the policy remains pretty much untouchable. In Italy, Renzi wants to loosen the country’s notoriously strict labour regulations but faces stiff opposition from the trade unions and the Left, not least in his own party. He now wants to give his government three years to implement reform, as he announced last week.
Draghi turns away from the Germans
German influence on the ECB is waning. It was this influence that kept alive the prospect of a somewhat different approach to economic challenges than the one adopted in the US, the UK and, interestingly, Japan. Of course, the differences should not be overstated. In the Eurozone, like elsewhere, we observed interest rate suppression, asset price manipulations, and massive liquidity-injections, and worse, even capital controls and arbitrary bans on short-selling. But we also saw a greater willingness to rely on restructuring, belt-tightening, liquidation, and, yes, even default, to rid the system of the deformations and imbalances that are the ultimate root causes of recessions and the impediments to healthy, sustainable growth. In the Eurozone it was not all about “stimulus” and “boosting aggregate demand”. But increasingly, the ECB looks like any other major central bank with a mandate to keep asset prices up, government borrowing costs down, and a generous stream of liquidity flowing to cover the cracks in the system, to sustain a mirage of solvency and sustainability, and to generate some artificial and short-lived headline growth. QE will not only come to the Eurozone, it will become a conventional tool, just like elsewhere.
I believe it is these two points, Draghi’s sudden hyperactivity (1) and his clear rift with the Germans and his departure from the German strategy (2) that may explain why the euro is finally weakening, and why the minor announcements of last Thursday had a more meaningful impact on markets than the similarly minor announcements in June. With German influence on the ECB waning, trashing your currency becomes official strategy more easily, and this is already official policy in Japan and in the US.
Is Draghi scared by the weak growth numbers and the prospect of deflation?
Maybe, but things should be put in perspective.
Europe has a structural growth problem as mentioned above. If the structural impediments to growth are not removed, Europe won’t grow, and no amount of central bank pump priming can fix it.
Nobody should be surprised if parts of Europe fall into technical recessions every now and then. If “no growth” is your default mode then experiencing “negative growth” occasionally, or even regularly, should not surprise anyone. Excited talk about Italy’s shocking “triple-dip” recession is hyperbole. It is simply what one should expect. Having said this, I do suspect that we are already in another broader cyclical downturn, not only in Europe but also in Asia (China, Japan) and the UK.
The deflation debate in the newspapers is bordering on the ridiculous. Here, the impression is conveyed that a drop in official inflation readings from 0.5 to 0.3 has substantial information content, and that if we drop below zero we would suddenly be caught in some dreadful deflation-death-trap, from which we may not escape for many years. This is complete hogwash. There is nothing in economic theory or in economic history that would support this. And, no, this is not what happened in Japan.
The margin of error around these numbers is substantial. For all we know, we may already have a -1 percent inflation rate in the Eurozone. Or still plus 1 percent. Either way, for any real-life economy this is broadly price-stability. To assume that modest reductions in any given price average suddenly mean economic disaster is simply a fairy tale. Many economies have experienced extended periods of deflation (moderately rising purchasing power of money on trend) in excess of what Japan has experienced over the past 20 years and have grown nicely, thank you very much.
As former Bank of Japan governor Masaaki Shirakawa has explained recently, Japan’s deflation has been “very mild” indeed, and may have had many positive effects as well. In a rapidly aging society with many savers and with slow headline growth it helped maintain consumer purchasing power and thus living standards. Japan has an official unemployment rate of below 4 percent. Japan has many problems but deflation may not be one of them.
Furthermore, the absence of inflation in the Eurozone is no surprise either. There has been no money and credit growth in aggregate in recent years as banks are still repairing their balance sheets, as the “asset quality review” is pending, and as other regulations kick in. Banks are reluctant to lend, and the private sector is careful to borrow, and neither are acting unreasonably.
Expecting Eurozone inflation to clock in at the arbitrarily chosen 2 percent is simply unrealistic.
Draghi’s new activism moves the ECB more in the direction of the US Fed and the Bank of Japan. This alienates the Germans and marginally strengthens the position of the Eurozone’s Southern periphery. This monetary policy will not reinvigorate European growth. Only proper structural reform can do this but much of Europe appears unable to reform, at least without another major crisis. Fiscal deficits will grow.
Monetary policy is not about “stimulus” but about maintaining the status quo. Super-low interest rates are meant to sustain structures that would otherwise be revealed to be obsolete, and that would, in a proper free market, be replaced. The European establishment is interested in maintaining the status quo at all cost, and ultra-easy monetary policy and QE are essentially doing just that.
Under the new scheme of buying asset-backed securities, the ECB’s balance sheet will become a dumping ground for unwanted bank assets (the Eurozone’s new “bad” bank). Like almost everything about the Euro-project, this is about shifting responsibility, obscuring accountability, and socializing the costs of bad decisions. Monetary socialism is coming. The market gets corrupted further.
The data was not really surprising and neither was the response from the commentariat. After a run of weak reports from Germany over recent months, last week’s release of GDP data for the eurozone confirmed that the economy had been flatlining in the second quarter. Predictably, this led to new calls for ECB action. “Europe now needs full-blown QE” diagnosed the leader writer of the Financial Times, and in its main report on page one the paper quoted Richard Barwell, European economist at Royal Bank of Scotland with “It’s time the ECB took control and we got the real deal, instead of the weaker measure unveiled in June.”
I wonder if calls for more ‘stimulus’ are now simply knee-jerk reactions, mere Pavlovian reflexes imbued by five years of near relentless policy easing. Do these economists and leader writers still really think about their suggestions? If so, what do they think Europe’s ills are that easy money and cheap credit are going to cure them? Is pumping ever more freshly printed money into the banking system really the answer to every economic problem? And has QE been a success where it has been pursued?
The fact is that money has hardly been tight in years – at least not at the central bank level, at the core of the system. Granted, banks have not been falling over one another to extend new loans but that is surely not surprising given that they still lick their wounds from 2008. The ongoing “asset quality review” and tighter regulation are doing their bit, too, and if these are needed to make finance safer, as their proponents claim, then abandoning them for the sake of a quick – and ultimately short-lived – GDP rebound doesn’t seem advisable. The simple fact is that lenders are reluctant to lend and borrowers reluctant to borrow, and both may have good reasons for their reluctance.
Do we really think that Italian, French, and German companies have drawers full of exciting investment projects that would instantly be put to work if only rates were lower? I think it is a fairly safe bet that whatever investment project Siemens, BMW, Total and Fiat can be cajoled into via the lure of easy money will by now have been realized. The easy-money drug has a rapidly diminishing marginal return.
In most major economies, rates have been close to zero for more than five years and various additional stimulus measures have been taken, including some by the ECB, even if they fell short of outright QE. Yet, the global economy is hardly buzzing. The advocates of central bank activism will point to the US and the UK. Growth there has recently been stronger and many expect a rise in interest rates in the not too distant future. Yet, even if we take the US’ latest quarterly GDP data of an annualized 4 percent at face value (it was a powerful snap-back from a contraction in Q1), the present recovery, having started in 2009, still is the slowest in the post-World-War-II period, and by some margin. The Fed is not done with its bond-buying program yet, fading it out ever so slowly and carefully, fearful that the economy, or at any rate overstretched financial markets, could buckle under a more ‘normal’ policy environment, if anybody still knows what that may look like. We will see how much spring is left in the economy’s step once stimulus has been removed fully and interest rates begin to rise — if that will ever happen.
Then there is Japan, under Abe and Kuroda firmly committed to QE-square and thus the new poster-boy of the growth-through-money-printing movement. Here the economy contracted in Q2 by a staggering 6.8% annualized, mimicking its performance from when it was hit by a tsunami in 2011. This time economic contraction appears to have been mainly driven by an increase in the country’s sale tax (I guess the government has to rein in its deficit at some stage, even in Japan), which had initially caused a strong Q1, as consumers front-loaded purchases in anticipation of the tax hike. Now it was pay-back time. Still, looking through the two quarters, the Wall Street Journal speaks of “Japan’s slow recovery despite heavy stimulus”.
Elsewhere the debate has moved on
In the Anglo-Saxon countries the debate about the negative side-effects of ultra-easy money seems to be intensifying. Last week Martin Feldstein and Robert Rubin, in an editorial for the Wall Street Journal, warned of risks to financial stability from the Fed’s long-standing policy stimulus, pointing towards high asset values and tight risk premiums, stressing that monetary policy was asked to do too much. Paul Singer, founder of the Elliott Management hedge fund and the nemesis of Argentina’s Cristina Fernandez de Kirchner, was reported as saying that ultra-easy monetary policy had failed and that structural reforms and a more business-friendly regulatory environment were needed instead. All of this even before you consider my case (the Austrian School case) that every form of monetary stimulus is ultimately disruptive because it can at best buy some growth near term at the price of distorting capital markets and sowing the seeds of a correction in the future. No monetary stimulus can ever lead to lasting growth.
None of this seems to faze the enthusiasts for more monetary intervention in Europe. When data is soft, the inevitable response is to ask the ECB to print more money.
The ECB’s critics are correct when they claim that the ECB has recently been less accommodative than some of its cousins, namely the Fed and the Bank of Japan. So the eurozone economy stands in front of us naked and without much monetary make-up. If we do not like what we see then the blame should go to Europe’s ineffectual political elite, to France’s socialist president Hollande, whose eat-the-rich tax policies and out-of-control state bureaucracy cripple the country; to Ms Merkel, who not only has failed to enact a single pro-growth reform program since becoming Germany’s chancellor (how long can the country rest on the Schroeder reforms of 2002?) but now embraces a national minimum wage and a lower retirement age of 63, positions she previously objected to; to Italy’s sunny-boy Renzi who talks the talk but has so far failed to walk the walk. But then it has been argued that under democracy the people get the rulers they deserve. Europe’s structural impediments to growth often appear to enjoy great public support.
Calls for yet easier monetary conditions and more cheap credit are a sign of intellectual bankruptcy and political incompetence. They will probably be heeded.
[Editor’s note: this article, by Brendon Brown, was first published by Mises.org.]
Just as Professor Bernanke exits center stage at the end of Act I of the monetary comedy he created, the scene shifts to Frankfurt. The star of Act II is European Central Bank (ECB) chief Mario Draghi. As we pick up the story, Mr. Draghi has been launching a defense against a phantom threat of deflation.
Meanwhile, our retired star is busy collecting top fees from appreciative “fans,” especially from Wall Street, an area where he once admitted “he had to hold his nose.” What are these fans hoping to gain from their fawning of ex-superstar Bernanke in this new world of monetary transparency, which he proudly claims to have created? Is it the privileged insights that come from networking and knowing how the replacement actor will handle the Fed’s machinery for manipulating long-term interest rates? It has been said that the new chief, rising star Janet Yellen, is “joined at the hip” to her predecessor.
Mario Draghi has yet to acknowledge how much the success of Act II depends on the quantitative easing from Act I, as written and choreographed by Professor Bernanke. The ECB illusionist scored his first big ovation from center stage by proclaiming he would do “whatever it takes to save the euro.” The global asset price inflation plague created by the Bernanke Fed turned those words into immediate virtual reality. Irrationally exuberant investors in their search for yield have been chasing any half-plausible story. Europe with its onetime array of high-yielding markets has been fertile ground for such speculative hypotheses, including Draghi’s boast.
The ECB president is impervious to the critics who say his new strategy of injecting an added strain of asset price inflation into the veins of the European economy, though bolstering the European Monetary Union (EMU) in the short-term, could be fatal in the longer term. That is no laughing matter, because the collapse of EMU in the next great asset price deflation in global markets could bring a monetary revolution.
The essence of comedy is inflexibility, not the volume of the laughter. Don Juan is comic because even when granted a last chance of repentance, or else face death by fire, he cannot change his ways. In the present Bernanke authored comedy, the central bank actors cannot stop trembling for fear of deflation. Yet there has been no actual or threatened monetary deflation during all the years of this long-running show (and well before then).
Under a hypothetical regime of monetary stability the invisible hand of market forces would cause there to be periods of falling and rising prices. The determination of the Federal Reserve to fight those natural down-waves in prices such as occur in business contractions, or under the influence of technological change, has been the source of outbreaks of asset price inflation culminating in great recession and in long-run diminution of economic dynamism.
The Bernanke-ite comedic characters, though, remain convinced that any episode of falling prices would mean economic catastrophe and they have conjured a whole folklore, spanning from the Great Depression to Japan’s Lost Decade, to demonstrate this misleading assertion. ECB chief Mario Draghi cites the fight against deflation as the principal reason for introducing negative interest rates on deposits at the ECB, and a further package of below market cost loans to weak banks.
Yes, prices, and even some wages have been falling in Spain and Italy. But this is simply a result of the unsustainable high levels that resulted from the asset and credit inflation of the last decade, and are now falling slowly in line with real equilibrium tendencies. In Germany, goods-and-services inflation is running at over 1 percent per annum and real estate price inflation is at 10 percent-plus in many cities.
Understandably the German media is voicing complaints by savers being penalized for the camouflaged purpose of aiding crony-capitalist bankers in southern Europe. Mario Draghi gives the standard response of the deflation phobic central banker: Non-conventional policy tools will stimulate a strong recovery which should ultimately benefit the rentier. Who is he kidding?
It appears he is kidding many. The boom in carry trade (the assumption of currency, credit, or maturity risk in the pursuit of higher yields), a key symptom of the asset price inflation disease which ECB and Fed deflation fighting created, now features 10-year yields on Spanish government bonds, below those on US bonds.
Many in the marketplace now question whether there ever really was a crisis in the European Monetary Union. The David Low cartoon comes to mind, John Bull rubs his eyes on March 13, 1939, asking whether the Munich crisis of the previous November was just a bad dream. No wonder the euro stays at high levels.
Back on stage, the Bernanke-ite comedians are now puppeteers, pulling the strings of their puppets, donning their Emperor’s new clothes (in the form of rate manipulation machinery the effectiveness of which depends on market irrationality), and waving their wands. The question of whether the comedians are themselves puppets does not cloud the minds of those in the audience mesmerized by the show, and expecting to cash their profits before speculative temperatures drop. The retired actor and author, in the twilight of his career, knows his appearance fees depend on the show’s continued power to mesmerize the crowd.
Max Rangeley is the Editor of The Cobden Centre. He is the CEO of ReboundTAG Ltd, which produces microchip luggage tags and has been showcased by Lufthansa and featured on BBC World among other media outlets. Max has a Master’s in economics, following this he was given a scholarship to do a PhD at the London School of Economics, but decided instead to go straight into business. | Contact us
30 June 14 | Tags: Central Banking, ECB, Economic Cycles | Category: Economics | Comments are closed
[Editor’s note: This article also appears on Detlev Schlichter’s blog here. It is reproduced with kind permission and should NOT be taken to be investment advice.]
There is apparently a new economic danger out there. It is called “very low inflation” and the eurozone is evidently at great risk of succumbing to this menace. “A long period of low inflation – or outright deflation, when prices fall persistently – alarms central bankers”, explains The Wall Street Journal, “because it [low inflation, DS] can cripple growth and make it harder for governments, businesses and consumers to service their debts.” Official inflation readings at the ECB are at 0.7 percent, still positive so no deflation, but certainly very low.
How low inflation cripples growth is not clear to me. “Very low inflation” was, of course, once known as “price stability” and used to invoke more positive connotations. It was not previously considered a health hazard. Why this has suddenly changed is not obvious. Certainly there is no empirical support – usually so highly regarded by market commentators – for the assertion that low inflation, or even deflation, is linked to recessions or depressions, although that link is assumed to exist implicitly or explicitly in the financial press almost daily. In the twentieth century the United States had many years of very low inflation and even outright deflation that were not marked by recessions. In the nineteenth century, throughout the rapidly industrializing world, “very low inflation” or even persistent deflation were the norm, and such deflation was frequently accompanied by growth rates that would today be the envy of any G8 country. To come to think of it, the capitalist economy with its constant tendency to increase productivity should create persistent deflation naturally. Stuff becomes more affordable. Things get cheaper.
“Breaking news: Consumers shocked out of consuming by low inflation!”
So what is the point at which reasonably low inflation suddenly turns into “very low inflation”, and thus becomes dangerous according to this new strand of thinking? Judging by the reception of the Bank of England’s UK inflation report delivered by Mark Carney last week, on the one hand, and the ridicule the financial industry piles onto the ECB on the other – “stupid” is what Appaloosa Management’s David Tepper calls the Frankfurt-based institution according to the FT (May 16) -, the demarcation must lie somewhere between the 1.6 percent reported by Mr. Carney, and the 0.7 that so embarrasses Mr. Draghi.
The argument is frequently advanced that low inflation or deflation cause people to postpone purchases, to defer consumption. By this logic, the Eurozonians expect a €1,000 item to cost €1,007 in a year’s time, and that is not sufficient a threat to their purchasing power to rush out and buy NOW! Hence, the depressed economy. The Brits, on the other hand, can reasonably expect a £1,000 item to fetch £1,016 in a year’s time, and this is a much more compelling reason, one assumes, to consume in the present. The Brits are in fact so keen to beat the coming 2 percent price hikes that they are even loading up on debt again and incur considerable interest rate expenses to buy in the here and now. “Britons are re-leveraging,” tells us Anne Pettifor in The Guardian, “Net consumer credit lending rose by £1.1bn in March alone. Total credit card debt in March 2014 was £56.9bn. The average interest rate on credit card lending, [stands at] at 16.86%.” Britain is, as Ms. Pettifor reminds us, the world’s most indebted nation.
I leave the question to one side for a minute whether these developments should be more reason to “alarm central bankers” than “very low inflation”. They certainly did not alarm Mr. Carney and his colleagues last week, who cheerfully left rates at rock bottom, and nobody called the Bank of England “stupid” either, to my knowledge. They certainly seem not to alarm Ms. Pettifor. She wants the Bank of England to keep rates low to help all those Britons in debt – and probably yet more Britons to get into debt.
Ms. Pettifor has a highly politicized view of money and monetary policy. To her this is all some giant class struggle between the class of savers/creditors and the class of spenders/debtors, and her allegiance is to the latter. Calls for rate hikes from other market commentator thus represent “certain interests,” meaning stingy savers and greedy creditors. That the policy could set up the economy for another crisis does not seem to trouble her.
Echoing Ms. Pettifor, Martin Wolf flatly stated in the FT recently that the “low-risk-seeking saver” no longer served a useful purpose in the global economy, and he approvingly quoted John Maynard Keynes with his call for the “euthanasia of the rentier”. “Interest today rewards no genuine sacrifice,” Keynes wrote back then, obviously in error: Just ask Britons today if not spending their money now but saving it for a rainy day does not involve a genuine sacrifice. Today’s rentiers do not even get interest for their sacrifices, thanks to all the “stimulus” policy. And now the call is for an end to price stability, for combining higher inflation with zero rates. It is not much fun being a saver these days – and I doubt that these policies will make anyone happy in the long run.
Euthanasia of the Japanese rentier
What the “euthanasia of the rentier” may look like we may have chance to see in Japan, an ideal test case for the policy given that the country is home to a rapidly aging population of life-long savers who will rely on their savings in old age. The new policy of Abenomics is supposed to reinvigorate the economy through, among other things, monetary debasement. “In as much as Abenomics was intended to generate strong nominal growth, I have been a big believer,” Trevor Greetham, asset allocation director at Fidelity Worldwide Investment, wrote in the FT last week (FT, May 15, 2014, page 28). “Japan has been in debt deflation for more than 20 years.”
Really? – In March 2013, when Mr. Abe installed Haruhiko Kuroda as his choice of Bank of Japan governor, and Abenomics started in earnest, Japan’s consumer price index stood at 99.4. 20 years earlier, in March 1994, it stood at 99.9 and 10 years ago, in March 2004, at 100.5. Over 20 years Japan’s consumer prices had dropped by 0.5 percent. Of course, there were periods of falling prices and periods of rising prices in between but you need a microscope to detect any broad price changes in the Japanese consumption basket over the long haul. By any realistic measure, the Japanese consumer has not suffered deflation but has enjoyed roughly price stability for 20 years.
“The main problem in the Japanese economy is not deflation, it’s demographics,” Masaaki Shirakawa declared in a speech at Dartmouth College two weeks ago (as reported by the Wall Street Journal Europe on May 15). Mr. Shirakawa is the former Bank of Japan governor who was unceremoniously ousted by Mr. Abe in 2013, so you may say he is biased. Never mind, his arguments make sense to me. “Mr. Shirakawa,” the Journal reports, “calls it ‘a very mild deflation’ [and I call it price stability, DS] that had the benefit of helping Japan maintain low unemployment.” The official unemployment rate in Japan stands at an eye-watering 3.60%. Maybe the Japanese have not fared so poorly with price stability.
Be that as it may, after a year of Abenomics it turns out that higher inflation is not really all it’s cracked up to be. Here is Fidelity’s Mr. Greetham again: “Things are not as straightforward as they were….The sales tax rise pushed Tokyo headline inflation to a 22-year high of 2.9 percent in April, cutting real purchasing power and worsening living standards for the many older consumers on fixed incomes.”
Mr. Greetham’s “older consumers” are probably Mr. Wolf’s “rentiers”, but in any case, these folks are not having a splendid time. The advocates of “easy money” tell us that a weaker currency is a boost to exports but in Japan’s case a weaker yen lifts energy prices as the country is heavily dependent on energy imports.
The Japanese were previously thought to not consume enough because prices weren’t rising fast enough, now they may not consume enough because prices are rising. The problem with going after “nominal growth” is that “real purchasing power” may get a hit.
If all of this is confusing, Fidelity’s Mr. Greetham offers hope. We may just need a bigger boat. More stimulus. “The stock market may need to get lower over the next few months before the government and Bank of Japan are shocked out of their complacency…When domestic policy eases further, as it inevitably will, the case for owning the Japanese market will be compelling once again.”
You see, that is the problem with Keynesian stimulus, you need to do ever more of it, and make it ever bigger, in an effort to outrun the unintended consequences.
Whether Mr. Greetham is right or not on the stock market, I do not know. But one thing seems pretty obvious to me. If you could lastingly improve your economy through easy money and currency debasement, Argentina would be one of the richest countries in the world today, as it indeed was at the beginning of the twentieth century, before the currency debasements of its many incompetent governments began.
No country has ever become more prosperous by debasing its currency and ripping off its savers.
This will end badly – although probably not soon.
What does it all mean? – I don’t know (and I could, of course, be wrong) but I guess the following:
The ECB will cut rates in June but this is the most advertised and anticipated policy easing in a long while. Euro bears will ultimately be disappointed. The ECB does not go ‘all in’, and there is no reason to do so. My hunch is that a pronounced weakening of the euro remains unlikely.
In my humble opinion, and contrary to market consensus, the ECB has run the least worst policy of all major central banks. No QE thus far; the balance sheet has even shrunk; large-scale inactivity. What is not to like?
Ms Pettifor and her fellow saver-haters will get their way in that any meaningful policy tightening is far off, including in the UK and the US. Central banks see their main role now in supporting asset markets, the economy, the banks, and the government. They are positively petrified of potentially derailing anything through tighter policy. They will structurally “under-tighten”. Higher inflation will be the endgame but when that will come is anyone’s guess. Growth will, by itself, not lead to a meaningful response from central bankers.
Abenomics will be tried but it will ultimately fail. The question is if it will first be implemented on such a scale as to cause disaster, or if it will receive its own quiet “euthanasia”, as Mr. Shirakawa seems to suggest. At Dartmouth he claimed “to have the quiet support of some Japanese business leaders who joined the Abe campaign pressuring the Shirakawa BoJ. ‘One of the surprising facts is what CEOs say privately is quite different from what they say publicly,’ he said….’in private they say, No, no, we are fed up with massive liquidity – money does not constrain our investment.’”
Though he quotes F.A. Hayek a few times, the Austrian School gets only one mildly disparaging mention in the entire book. This seems odd for an author who devotes a whole chapter to the benefits of the gold standard. His first bestselling book, Currency Wars, argues that currency wars are not just an economic or monetary concern, but a national security concern for the USA.
Rickards relies on emerging Chaos theories of economics and markets (1) to buttress his arguments in favour of sound money and prudent – limited – government. He uses the same insights, twinned with years of Wall Street experience, to explain why the “coming collapse of the dollar and the international monetary system is entirely foreseeable.”
One of Rickards’ key arguments is that exponential increases in the total size of credit markets mean exponential increases in risk. The gross size of derivative markets is the problem, irrespective of false assurances about netting, he claims. Politicians and central bankers have by and large learnt nothing from recent crises, and are still “in thrall to bank political contributions.”
He makes the case for the US federal government to reinstate Depression-era restrictions on banking activities and for most derivatives to be banned. As a former Federal Reserve Chairman, Paul Volcker, said in 2009, “the only useful thing banks have invented in 20 years is the ATM” – a sentiment Rickards would probably be sympathetic to.
The chapter dealing with the Fed’s hubris and what investment writer James Grant calls our “PhD Standard” of macroeconomic management will be familiar territory for readers of this site. The Fed is trapped between the rock of natural deflationary forces of excessive debt, an ageing population and cheap imports frustrating its efforts to generate a self-sustaining economic recovery and the hard place of annualised inflation of 2%. Rickards quotes extensively from eminent economist and Ben Bernanke mentor Frederic Mishkin, who noted in a 2013 paper titled Crunch Time: Fiscal Crises and the Role of Monetary Policy that “ultimately, the central bank is without power to avoid the consequences of an unsustainable fiscal policy.”
More interesting is the author’s attempt to map out what-happens-next scenarios. The chapter about the on-going transformation of the International Monetary Fund into the world’s central bank, and Special Drawing Rights (SDRs) into a global currency, is particularly insightful. Though Rickards doesn’t say it, Barack Obama’s former chief of staff (and current Mayor of Chicago) Rahm Emanuel’s dictum about never letting a crisis go to waste seems to apply here: hostile acts of financial warfare would lead to calls for more international regulation, and to more government intervention and monitoring of markets. Observers of the EU’s crab-like advance over the last half century will be familiar with the process.
Indeed, my only quibble with this book is Rickards’ starry-eyed take on the EU – soon to be “the world’s economic superpower” in his view. Though he makes a good argument – similar to Jesús Huerta de Soto’s – that relatively-tight European Central Bank monetary policy is forcing effective structural adjustments in the eurozone periphery, as well as in eastern states that wish to join the euro, his endorsement of other aspects of the EU seem too sweeping.
The author talks of the benefits of “efficiencies for the greater good” in supranational government, and how subsidiarity makes allowances for “local custom and practice”. But, as the regulatory débacle surrounding the Somerset floods has shown recently, EU rule frequently licenses bureaucratic idiocies that destroy effective, established national laws. Regulatory central planning for an entire continent is, I’d say, just as suspect as monetary central planning for one country.
The continent’s demographic problems are probably containable in the short-term, as Rickards says. But mass immigration is driving increasing numbers of white Europeans to far-right parties. And while there is consistently strong public support for the euro in the PIIGS (Portugal, Ireland, Italy, Greece and Spain), he’s silent on the broader question of the EU’s democratic legitimacy. No mention of those pesky ‘No’ votes in European Constitution, Maastricht and Lisbon Treaty referendums – or of the Commission’s own Eurobarometer polls, which show more and more Europeans losing faith in “the project”.
No matter I suppose: the eurocrats will rumble on regardless. But what was that quote about democracy being the worst form of government apart from all the others?
All in all though, this is a great book – even for someone like me who’s not exactly new to the economic doom ‘n’ gloom genre. As Rickards says at the end of his intro: “The system has spun out of control.”
(1) For example Juárez, Fernando (2011). “Applying the theory of chaos and a complex model of health to establish relations among financial indicators”. Procedia Computer Science 3: 982–986.
Once again, the European press is trumpeting the triumph of the prodigals after a week in which both the Spanish and the French were accorded more time to get their budgetary house in order – a move which, given the downward economic trajectory of the pair, has something of a whiff of force majeure about it – and the German Finance Minister Schaeuble acknowledged that, yes, the fiscal pact around which he and his boss have built so much of their electoral credibility did in fact encompass a ‘certain flexibility’.
In the wake of a mass demonstration on the streets of Paris at which the Left Front’s heavily-defeated presidential candidate Melenchon fulminated that “We do not want the world of finance in power!” – an expostulation delivered to the strains of ‘Ca ira!’, one supposes – Schaeuble’s Gallic counterpart Moscovici was hardly in a position to soft-pedal the German concession, instead vaunting grandiosely in his turn that, “We are witnessing the end of the dogma of austerity… we are at a decisive turning point in the history of the European Project”.
Brave words, indeed, but Frau Merkel, for one, begged to disagree – or, at least, to dissemble for the benefit of her domestic audience. “If one regularly spends more than one earns, something must be awry,” she opined, while one of her party’s spokesmen, Steffen Seibert declared that, “Our contention is that the… crisis has its roots in the overindebtedness of many member states… in to low a degree of competitiveness.” No prizes for guessing to whom he was referring.
Last week’s supposed poster boy for the new laxity, Commissar – sorry, Commissioner – Barroso, was also out on the circuit, denying that he had endorsed any such slippage by telling Welt am Sonntag that he had been “deliberately misinterpreted”, that – au contraire, mes amis – “growth which depends upon debt is unsustainable” and that the blame for the ‘Project’s’ woes should not be pinned on German policy but rather on “excessive outlays, lack of competitiveness” – that word again – “and irresponsible finance.” “Each nation,” he went on, “should look to clean up the mess on its own doorstep.”
Amid all this posturing, it does strike your author as a touch ironic that while the commentariat treats Europe’s persistence with its failed experiment in ‘fauxterity’ as a clear and undeniable symptom of the mental inadequacy of its ruling elite, the members of that same consensus themselves retain what is, if anything, an even more delusional faith in the combined evils of inflation and Big Government as the magical means with which to conjure away all our present woes.
In case you hadn’t noticed, fellas, we have been reinforcing monetary-fiscal failure for the past five years, by continuing to ply the patient with ever stronger doses of what it was that made him ill in the first place. Just multiply the DAX by the youth unemployment rate if you want a snapshot of where your approach has gone horribly wrong – of where you have let the GINI out of the bottle, as it were – and you might realise that if there is anyone who needs to reconsider their attachment to a discredited dogma, it is you!
Whisper it, but even your hero seems to be getting the drift. For witness that, in his latest speech in Rome, Mario Draghi was happy to say that “Fiscal policies must follow a sustainable path, separate and distinct from cyclical fluctuations. Without this prerequisite, lasting growth is not possible… Particularly for countries with structurally high levels of public debt…”, before going on to assert far more boldly that – as we have said since Day One of the crisis – “…to mitigate the inevitable recessionary effects of fiscal consolidation, the composition of such measures must favour the reduction of current public spending and of taxes, particularly in a context such as in Europe where taxation is already high by international standards….” [our emphasis].
Though we must be careful not to read too much into the man’s words, it is hard not to hope that this might reflect the first fragile flowering of a genuinely new approach – of the inauguration of a policy of REAL austerity, this time of the invigorating kind which incorporates a partial lifting of the deadening hand of the state, rather than the enervating, bastardized version of slower spending growth and rapidly rising taxes with which we have been so far afflicted and which has only served to compound the financial shock delivered by the collapse of the last bubble.
All this remains to be seen but, in the here-and-now, the temptation to use this effusion of political hot-air as an excuse to buy yet more stocks, more ailing sovereign debt, and more junk credit has become well-nigh irresistible, especially since Super-Mario not only overrode what he hinted was some internal opposition to an official rate cut at the latest ECB meeting, but also managed to leave dangling before a slavering crowd of stimulus junkies a tantalising hint that he might soon push the level below zero. In case we were too obtuse to get the point, he underlined his intentions with another of his famously portentous, almost Delphic pronouncements: that even though the ECB council was still scrambling to divine whether anything could possibly go wrong with such step into the unknown, he, Draghi, stood ‘ready to act’.
It was not the first time in recent days, of course, that the marbled halls of Mount Olympus had echoed to the sonorous baritone of the Gods as they sought to reassure us poor mortals that they had matters well in hand: that they had taken time off from their weighty contemplation of the sublime, the eternal, and the infinite to tend instead to our petty concerns. Had not the Bernanke Fed subtly quashed all thoughts that it might soon ‘taper’ its own open-handed distribution of milk and honey with that one, equally Pythian phrase: “the Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation”?
How can a man NOT want to buy the market in the face of the solicitous stance being taken by the venerated possessors of such unchallenged omniscience?
For all this, the imposition of the near-mythical, negative deposit rate might seem to entail more problems than advantages, not least because it would effectively act as a tax, a drain upon the earnings, of the very same banks that the last five year’s ruinous policies have been attempting to bolster. Bear in mind that, even after the recent redemptions, European banks have a hefty €628 billion parked with the ECB and so a 50bp levy on this could amount annually to perhaps 15% of industry-wide profits.
Nor can banks simply avoid this by withdrawing their funds: outside money – the kind created by the central bank – is, after all – outside. This means that its supply can only be altered with the complicity of the bank of issue itself which must therefore allow its myrmidons to pay back more of their LTROs, covered bond repos, and so forth – a reduction of liquidity which one might think would run counter to the original intention. Thus, one supposes, the idea will be that the banks will enact the Gesellian wet dream of passing on the cost to their own depositors, of taxing their money instead.
Here we must consider the fact that while the individual can easily seek to disembarrass himself of what he now considers an excess proportion of money among his holdings, collectively the public can only have their aggregate stock of inside (bank-created) monies diminished in one of three ways: they must repay their loans (deleverage further); the banks themselves must call in said loans (intensify the crunch); or people who hold a demand account must swap it for a term deposit (which does not constitute money-proper), or invest in a long-term security issued by the bank itself (we specify this last because a moment’s thought will reveal that the purchase of non-bank paper simply passes the parcel to the seller or issuer of said obligations who must then rid himself of them in his turn).
While that latter condition might seem an ideal juncture at which the banks could seek to boost their levels of capital (albeit at an average price:book of significantly less than one), the truth is that what the authorities seem most keen to provoke is a what is technically called a ‘monetary disequilibrium’ – that is, the situation where the public’s demand to hold money is thrown out of kilter. Under such conditions – and given the nominal inflexibility discussed above – the money stock can only be effectively reduced if its real value falls; if prices rise and so reduce its worth; i.e., if there is an inflation.
In that regard, the impulse to buy stocks on what is no more than a vague expression of intent might not seem so wholly irrational, after all. To see this in what is admittedly a toy example, suppose that half the population holds only cash and no equities (call these sticks-in-the-mud Group A), while the remainder has a reverse proportion of all equities, no cash to an equal overall nominal value held in their portfolios (call the ‘Nothing but Blue Skies’ crowd, Group B). The aggregate cash ratio from which we start is therefore 50% (albeit thanks to a not-to-be-exceeded and somewhat unrealistic divergence of preferences between our two cohorts).
Now suppose the members of Group A change their outlook on life and seek to acquire equities from Group B, paying successively higher prices for ever smaller increments in order to tempt their counterparts into the trade. Under some fairly crude assumptions, after four rounds of such bidding, with one third of the stock of equities having exchanged against two-thirds the stock of money, equity prices will have tripled, the cash ratio of both groups will have converged on 25%, and aggregate net worth will have doubled (to the relative advantage of the initial equity holders, but to the outright, if decidedly notional, benefit of all).
Note, however, that none of this says that the equities are worth three times as much for even if the monetary disturbance has somehow meant that earnings have also tripled (and this is far from being guaranteed even should revenues rise in proportion), this may represent no material gain whatsoever, but only register the inflation of a wider range of prices which here has not been consequent upon an increase in the stock of money per se but solely upon a diminution in its societal valuation.
Herein lies the great gaping hole at the centre of official policy. Yes, the central banks can increase the stock of outside money almost without limit. Yes, they can make it as unattractive as possible for anyone to hold this (though when we come to think about the impact of negative rates, let us not forget that people are generally happy to pay to have their other valuables safely stored, or that bank charges used to be a routine imposition upon the short-term depositor). And yes, to some extent they can assume that their actions will enhance the relative appeal of things other than money or its partial substitutes.
But what they cannot ever gauge is how much influence they can exert, nor how quickly their will may be done, nor even upon what specific mix of goods, services, or claims their policy will have most impact. As the great Richard Cantillon pointed out three centuries since, the whole question is highly path dependent and the path actually followed will be the result of an incredible cascade of interactions between individual, subjective choices, each one altering the quantum field in which the next has to be taken. As we Austrians have been saying for the past one hundred years, this affects relative prices much more profoundly than it does average ones. Crucially, it is in that matrix of relative prices that you find the motivations for all economic actions and the justification or otherwise for both the composition of the capital stock and the distribution and employment of labour. If entrepreneurial uncertainty and personal bewilderment have been major contributors to our ongoing malaise, as many of us have been arguing, it should be clear that we seek to introduce further sources of instability and potential disruption only at our peril.
Nor can our Sorcerer’s Apprentices be entirely sure that, as the demons they have summoned out of the vasty deep continue to chip away at the foundations of trust in the very currency which they, the necromancers, are charged with upholding, they do not unleash a catastrophic collapse of the whole superstructure of values and contractual chains which towers above them, reducing the whole economic system to chaos in the process.
If you can convince me that any mortal can hold such a complex tangle of possible outcomes within their comprehension, I will allow that our monetary heretics may be right to do away with the combined practical experience and theoretical understanding of all those who have gone before them over the ages. Until you do, I shall be forced to withhold my endorsement and to mutter darkly about the unexpiable sin of hubris instead.
Sean Corrigan is an economist of the Austrian School Liberal tradition. Corrigan blogs at www.truesinews.com - See more at: http://www.cobdencentre.org/author/scorrigan/#sthash.3GLJwf1s.dpuf | Contact us
10 May 13 | Tags: ECB, Federal Reserve, Inflation | Category: Economics | One comment
Under President Obama the debt of the United States government has grown by about 50%, and now stands at close to $16 trillion. Every year, the US government spends between $1.2 and $1.5 trillion more than it takes in. Every day that financial markets are open the US government has to borrow an additional $4 billion.
The pathetic fiscal cliff ‘compromise’ of last week has proved the most cynical students of the political elite correct in that there is not a snowball’s chance in hell that Washington will ever get this under control.
Can this go on forever? No, it cannot — although adherents of the Church of Modern Monetary Theory now proclaim that its holiness, the State, is not restricted by earthly matters, and that no limits apply to it. “It simply prints the money!” Back on earth, however, such recklessness has consequences, and these consequences will ultimately put a very nasty end to proceedings. But politics will not fix this. This much is certain.
One of the annoying little things that stand in the way of more debt is the dreaded debt ceiling debate, a quaint congressional tradition according to which the politicians in Washington have to periodically pretend that they can indeed exercise self-constraint and that they would even obey self-imposed limits. After the usual self-serving theatrics, both parties agree that the debt ceiling should be lifted, that spending must continue, and that more debt should be accumulated – in the interest of the American people, the US and the global economy, social peace, and because the show must go on.
Since March 1962, the debt ceiling has been raised 74 times.
Enter The Coin!
In order to make this farce a tad easier next time, the following plan has been concocted. It has recently made the headlines. You can read about it here and here:
The U.S. treasury is to issue a platinum coin with a notional value (that is, a value that is fixed entirely arbitrarily by the government) of $1 trillion, and this coin is deposited with the Federal Reserve. In fact, the coin is used to pay down $1 trillion of US government bonds held presently by the Fed (The Fed holds more than $2 trillion in government bonds). Thus, tradable government debt that counts against the debt ceiling is swapped for a ‘commemorative’ coin that does not count against the debt ceiling. $1 trillion of government debt thus magically disappears.
The US government has its fans who believe that anything, legally or illegally, should be done to keep it living beyond its means for as long as possible. These fans are supporting the plan. Among them is, not surprisingly, Paul Krugman, who fears nothing more than a congressionally enforced coitus interruptus before the protracted orgy of money-printing and deficit-spending has a chance to climax – as he keeps promising us – in a wonderful return of self-sustaining growth.
But the plan has many critics. Their criticism strikes me, however, as rather naïve and faint, and also missing the true significance of it all.
The critics make the following points:
1) This is just a trick and may not be legal.
2) It eases the pressure on politics to reduce the deficit meaningfully.
3) This could lead us onto the dangerous road toward debt monetization and could be inflationary.
Let me address each of these points before I come to what I consider the most important aspect of this.
Ad 1): Oh pleeeeze! Is it a trick? Is it a gimmick? Could it be illegal? – Are you stuck in the 1980s? – Of course, it is a trick and probably illegal! But who cares? Please get real. We have long passed the point at which any of the major governments feel constrained by such things as constitutions, laws, contracts or past promises. We live in a time of ‘anything goes’. Remember: “We will do whatever it takes!”
Look at Europe: From the start of the European debt crisis to today, EVERY rule that was set up at the start of EMU in order to govern it and to discipline its members, has been violated, ignored or shamelessly re-interpreted. The political class is making up its own rules as it goes along. Parliaments are rubber-stamping everything, and if they hesitate they are told that they could be held responsible for the ‘next Lehman’. Sign here, or else….
As I explained here, the US government has already abandoned habeas corpus, has arbitrarily annulled private contracts and will force Americans into commercial transactions. You think they will stop at the laws governing the issuance of commemorative coins? Do you really think that the army of lawyers that works for Washington cannot come up with a reasonably acceptable explanation (read: this side of totally laughable) for whatever the government wants to do that will sufficiently appease the folks at Harvard Law Review?
We may not get this specific version of the plan but something similar will certainly be implemented in the near future. You can bet on it. It is simply in line with current modes of thinking and the present political culture – or lack thereof.
Ad 2) The politicians will feel less pressure to enact real budget reform. – Oh come off it! There is neither real desire nor ability nor the required character and decency among the political elite to fix this self-inflicted budget mess. If you needed a reminder of the spinelessness and stupidity ruling Washington you only have to look at the great fiscal cliff compromise that was reached last week and that the equity market, evidently still on a drug-high from snorting unlimited lines of free central bank money, has been celebrating deliriously ever since. Let me say this in reference to a great quote by the incomparable P.J. O’Rourke: To expect Washington to reform itself and rein in spending is akin to giving your car keys, your credit card and a bottle of Jack Daniels to your 17-year old son and expect him to act responsibly.
Ad 3) Could this be the start of debt monetization?
Debt monetization has been going on for years, is alive and kicking, and gets bigger by the day. In the US and Britain, the central banks are the largest holders of their respective governments’ debt and the largest marginal buyers. The Bank of England has monetized about 30 percent of outstanding debt and now has more UK Gilts (government bonds) on its balance sheet than the entire UK pension and insurance industry combined. Under its current program of ‘open-ended’ QE3 (or QE4, or QEwhatever) the Fed buys $85 billion worth of new Treasuries and other securities every month.
Let’s get this straight: The whole raison d’etre of central banks is that they print money to fund the state. The Bank of England – the mother of all central banks – was set up specifically for this purpose in 1694. Since then a whole list of elaborate excuses has been drawn up for why central banks are needed and useful, a list that looks more ridiculous by the day: Central banks control inflation and guarantee monetary and economic stability? The exact opposite is true: Central banks create inflation and cause monetary and economic instability. There is no escaping the conclusion that they are organs of state planning and systematic market manipulation and thus fundamentally incompatible with the free market. But one true purpose remains: funding government. Increasingly, it is the dominant function of the ECB, the Bank of Japan, the Bank of England, and the US Federal Reserve to secure cheap credit for their respective governments and their out-of-control spending programs.
There is nothing new, surprising, or shocking about the $1 trillion coin proposal. It is perfectly in tune with the zeitgeist and with established trends in politics.
Bernanke will need a new script
So, what is significant about it? – Only one thing in my view: It exposes Bernanke as a liar.
Remember that Bernanke, and also his other central bank chums, such as Mervyn King and Mario Draghi, have tried to maintain the myth that they could one day – if markets allowed it or required it – reduce their bloated balance sheets. During the financial crisis, the Fed has ballooned its balance sheet from $800 billion to close to $3 trillion. We are supposed to believe that this is all temporary. Just to provide a stimulus. Nobody calls this debt monetization or ‘funding the government’. Same in Europe: Mervyn calls it ‘unlocking the credit markets’, Mario calls it ‘making sure the monetary transmission mechanism works’. The idea is that when the economy is finally mended the central banks can ‘normalize’ their balance sheets. More importantly, should inflation concerns arise, the central banks would quickly mop up all the excess bank reserves that they provided through ‘quantitative easing’ and sell the very assets they accumulated during the easing cycle. That would mean liquidating the central bank’s holdings of – among other things – government bonds.
But once the government has replaced liquid government bonds on the central bank’s balance sheet with illiquid coins the central bank’s maneuverability is severely restricted. When the public gets nervous about inflation, the central bank would have to reverse its crisis-policies and sell assets. There is (still) a market for US Treasury debt. However, there is no market for $1 trillion coins.
While the central bankers try to convince the public that their buying of government debt is a special case, an exception, a temporary policy measure, and that they could still defend the value of paper money if circumstances require, the politicians have other plans. They already consider central bank buying a permanent source of funding – unlimited and ever-lasting. I have long maintained that the central banks have no ‘exit strategy’, that they will simply not be allowed to reverse course. This is now becoming part of the official narrative, and central bankers who maintain otherwise are either hopelessly deluded or simply lying.
The deficits are here to stay and they will be funded by the printing press. No limit, no end, no exit.
Will this lead to inflation? _ Well, unless you are a fully signed-up member of the Church of Modern Monetary Theory, you know the answer.
Episode 73: GoldMoney’s Andy Duncan talks to Godfrey Bloom, who represents Yorkshire and North Lincolnshire in the European Parliament, and who is a member of the parliament’s Committee on Economic and Monetary Affairs. They talk about the possibility of Germany instituting a gold-backed Deutschmark, and broader issues to do with European monetary and fiscal policy.
In a recent Mises.org daily article co-authored with Patrick Barron, Mr Bloom states that Germany now has a “Golden Opportunity” to get back to sound money by pulling out of the euro and introducing a gold-backed Deutschmark. However, given the lack of a comprehensive audit, suspicions about the integrity of the German gold reserves remain. Bloom therefore advocates that Germany should repatriate its physical gold from the storage locations abroad.
They also talk about monetary policies of the European Union, the errors of European politicians and whether or not the eurozone can be sustained. In addition, they also discuss Britain’s relationship with the EU and Britain’s own precarious financial position, particularly in relation to its welfare state and deficit spending.
This podcast was recorded on 21 November 2012 and previously published at GoldMoney.com.