By Kevin Dowd
Talk to 39th Annual Cato Institute Annual Monetary Conference
“Populism and the Future of the Fed”
18 November 2021
“Good afternoon, everyone.
My thanks to Cato for the invitation to speak.
I’d like to take my cue from the conference theme – populism and the Fed.
Let’s first consider the context.
The context is the aftermath of the GFC and the Fed’s exit problem – how to raise rates without crashing the financial system, which is addicted to Fed support.
We have the disappearing line between fiscal and monetary.
The Fed acquires quasi-fiscal powers whilst its independence is undermined.
We have populist demands for the Fed to ‘print money’ to obtain supposedly ‘free’ goodies – the Green New Deal or whatever – and the illusions of free money, fairy dust and a Magic Money Tree.
We have attendant dangers of high inflation and eventual fiscal default.
Then we have the various policies being suggested.
Not just helicopter money and QE, but higher deficits, continued low rates, MMT, NIRP, the abolition of cash, central bank climate policy and Central Bank Digital Currencies.
From the perspective of someone who wants good money, this is a freak show!
In one way or another, these threaten the core foundations of a free society, in many ways.
CBDCs are especially dangerous as they could give the govt. complete control over all spending.
CBDCs entail the creation of weaponizable money with totalitarian implications.
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One possibility is more deficit spending.
But this would increase the govt’s debt/GDP ratio and further shift the burden of paying for current spending onto future taxpayers.
This would entail major intergenerational equity issues.
It could also undermine govt solvency in the long run.
The ratio of federal debt and entitlements to GDP is already at unprecedented levels and rising fast.
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Another possibility is continued low rates.
But these would further aggravate the damaging effects of low rates so far.
They would further stimulate the everything bubble and lead to even more risk taking, leverage and debt.
They would also worsen the damage already done to savers, pension funds and capital allocation.
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More QE
QE is the policy of issuing base money to finance large scale purchases of financial assets.
QE entails preferential credit allocation policy which is bad.
To paraphrase Larry White
QE “is a kind of central planning in which [Fed] officials … substitute their judgment for the financial market’s about the right prices and flows of funds… [It] throws good resources after bad. It incentivizes socially unproductive lobbying efforts [and] creates tremendous moral hazard and an environment ripe for cronyism.”
QE also raises the danger of fiscal dominance –the risk that the Treasury will eventually call the shots over monetary policy.
QE then becomes fiscal QE.
Not to mention that QE was “the greatest backdoor Wall Street bailout of all time,” at least until Covid.
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Helicopter Money is a policy under which the Fed prints money – physically or electronically – and gives it away to private parties or the govt.
Now helicopter money might seem to be ‘free’ but it isn’t.
To an economist ‘free’ means there is no opportunity cost.
But helicopter money always has an opportunity cost!
A helicopter drop to the public is fiscally equivalent to a tax cut, because people can use the helicoptered money to pay taxes.
A helicopter drop to the govt is merely an issue of transfer pricing within the public sector considered to include the central bank.
The helicoptered money ‘dropped’ on the govt is transferred at a zero price.
So helicopter money creates the illusion but not the reality of ‘free money’.
This creates political demands for ‘free’ Fed handouts.
These undermine Fed independence and especially if the Fed acquiesces.
Also, a helicopter drop to the public involves the Fed engaging in redistribution and redistribution is a fiscal issue.
To paraphrase David Stockman
“[QE] is a central bank power grab that insinuates unelected central bankers into the heart of the fiscal process.
The framers delegated the powers of the purse to the elected branch of govt because the decision to spend, tax and borrow is the very essence of state power and should not be removed from popular control.”
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Next, MMT.
The idea is that the govt spends a lot financed by the Fed printing base money to pay for it.
Advocates claim that the govt cannot default because it can always finance its spending by printing more money.
MMT goes hand in hand with insouciance over deficit finance.
We are told that “deficits don’t matter.”
Well, I can assure you that the govt CAN default and that fiscal deficits DO matter!
MMT will not work because it doesn’t scale.
First, the scale of government spending is way too large to be financed by printing money without triggering high inflation.
Second, my simulations suggest that MMT would likely lead to eventual hyperinflation AND govt default.
MMT is also to be rejected because it has no theory of the price level.
It allows no role for any plausible explanation of prices i.e. the Quantity Theory of Money.
Under MMT, a rise in inflation is to be countered by raising taxes!
Reducing the rate of growth of the money supply does not enter into it.
This is Flintstones era Keynesianism and we know how that turned out.
MMT is not based on Bedrock sound money principles.
It’s the opposite.
In a nutshell:
“MMT comes down to this: the government spends a lot, issues a lot of debt, and prints a lot of money. It is not as if it hasn’t been tried before.”
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Then we have negative rates, NIRP.
NIRPers recommend NIRP to ‘break through’ the Zero Lower Bound barrier to stimulate spending.
But if a central bank were to push rates more than a little below zero, deposit-holders would simply flee to cash.
To avoid such an outcome, policymakers would need to abolish cash.
This is a not a clever idea.
It would deprive users of the benefits of cash like convenience and anonymity.
It would expropriate people’s assets.
It would enable digital payments firms to increase their fees.
It would cause problems for vulnerable groups like the elderly.
It would make everyone dependent on fallible digital technology.
And it would end what’s left of financial privacy.
Back to NIRP.
NIRP entails a negative policy rate that pulls other rates down.
A neg rate was first implemented by the Riksbank in 2009.
A few other countries followed suite.
But these NIRP experiments were only ever ‘mild’ – the rate never went below minus 75 basis points.
Central banks didn’t dare go further.
Pushed too far, NIRP risks major disruptions to the financial system.
NIRP becomes more distortive, the further rates are pushed below natural levels.
But NIRP does not imply that all rates will become negative, however low policy rates go.
This is because the demand for positive rates will remain due to time preference and the productivity of capital.
And because it is easy to financially engineer positive rate instruments from negative rate ones.
But the important point is this:
From a policy perspective, NIRP is self-defeating.
It is advocated to promote stimulus, but how could NIRP ever be stimulative?
NIRP is a tax on bank deposits and no tax is stimulative!
To quote Fed governor Chris Waller, “negative rates are a tax in sheeps’ clothing.”
I agree.
Neg rates are a fleece, but not a golden one.
The empirical evidence confirms that NIRP failed to stimulate and had adverse effects besides.
And two years ago the Riksbank abandoned it as a failure.
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Then there is the issue of central banks getting into the climate change racket.
I suggest they shouldn’t.
First, they don’t have the legislative mandates to do so.
Second, they lack the competence to address long-term climate risks.
They can’t possibly know what to do – we are talking pretence of knowledge here.
Third, they lack policy instruments for the long horizons involved and the measures proposed have no chance of success.
They will burden the economy and weaken the financial system.
Central bank climate policy is another make-work project for regulators and consultants.
To quote John Cochrane:
“Central banks rushing headlong into climate policy is a mistake.
It will destroy central banks’ independence, their ability to fulfil their main missions to control inflation and stem financial crises, and it won’t help the climate.”
“A central bank in a democracy is not an all-purpose do-good agency, with authority to … defund what it dislikes, and force banks and companies to do the same.”
The point, of course, is NOT to say that nothing should be done about climate issues, but that whatever should be done should not involve central bankers meddling with it.
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Finally, Central Bank Digital Currency.
At one level, CBDCs are harmless but pointless.
But I would like to consider them in their most potent form.
The central bank sets up a digital currency, compels everyone to use it and abolishes substitutes like cash.
Such a system entails seriously adverse effects on the banking system
These include the dangers of a major contraction in bank lending and having bureaucrats replacing bankers in allocating bank credit.
I can’t see that working myself.
CBDCs also have no end of undesirable policy uses.
They could be used to implement NIRP or as a vehicle for helicopter money.
If the central bank wants to boost spending, it could announce that it will cancel or tax money holdings to encourage people to spend more –
CBDCs with expiry dates could be used to prevent money ‘hoarding’.
Demand management then becomes demand control.
If the central bank wants to reduce inflation, it could cancel some of the money it had created earlier.
CBDCs offer new tools for climate policy.
Central banks could apply differential treatment.
So ESG get better rates; and diesel and coal get penal rates.
CBDCs also have enormous potential for those who like to operate on the ‘Dark Side’.
CBDCs are programmable monies and these can be programmed to be weaponizable.
They could be programmed to block unapproved expenditures.
They could be programmed to cancel anyone’s money holdings in an instant.
CBDCs would entail total control over all spending.
They could be used to impose any political agenda.
To go after political enemies, real or imagined, or to punish people who express the wrong views.
Punishments could vary from mild to outright cancellation, where the victim is cast out of the monetary economy to survive as best they can.
For those who like to control other people’s lives, CBDCs make for a powerful future lockdown tool.
They could be used to ensure that people could only spend within a certain distance of their home, could only spend on approved items at approved times and could be compelled to get jabbed.
And, as the ultimate accessory in digital totalitarianism, CBDCs could be used to implement CCP-style Social Credit policies.
One might almost say that CBDCs “were concocted in Hell by Satan himself.”
Amen to that!
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Let me come to a close.
Recall first that central banks had straightforward mandates – mainly to deliver monetary and financial stability.
These are not difficult tasks to perform, but they couldn’t even do those properly.
So now they are saying, give us more to do and we promise to deliver.
Sure.
The problem is that central banks are trying to do too much.
Mervyn King said 21 years ago
“I tell you that our ambition at the Bank of England is to be boring. …
Fast forward to the present and King has this to say:
“The global financial crisis and its aftermath greatly expanded the role of central banks.
Central banks became “the only game in town.
Central bankers responded willingly, moving into the political arena” … and risking their independence.
I would go further.
By stepping into the political arena they voluntarily surrender their independence – but independence works both ways and is not a flag of convenience.
By taking on tasks they are unsuited to carry out, we can be certain that central banks will fail to deliver.
If we are to have central banks at all – and I would rather we didn’t – then let’s keep their mandates to the minimum and expect less.
As far as central banks are concerned, keep it simple, keep it clear and remember that boring is best.
Thank you all.”
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The proceedings of the conference will be published as Populism and the Fed, edited by James A. Dorn (Washington, DC: Cato Institute) in March next year.
