In response to an FT article by Martin Wolf on 17th March 2016, entitled 'The age of uncertainty is upon us'
'The first shift should be towards policies likely to raise productivity growth. An essential element in such a shift must be towards higher public and private investment. The government should invest more. It should also be looking at changes in the system of taxation that would encourage investment'
In order to understand the lower rates of productivity since the financial crisis of 2008, and to have any chance of reversing the downward trend, we have to understand the context in which economic activity takes place, I.E.:
1. The monetary environment in which individuals and businesses make decisions…and more specifically…
2. The ‘signals’ provided by that environment, which encourage either consumer optimism or pessimism; which encourage either expansive or defensive business strategies…and more specifically…
3. The most important of these signals - the price of money – the interest rate
For the past eight years interest rates have been sending all the wrong messages to individuals and businesses, at least if you are looking to encourage optimistic behavior and expansive strategies. Moreover, the interest rate regimes we have witnessed in the west have encouraged the total opposite of what is required.
a) Low interest rates encourage bubbles in asset prices. As they expand, banks make loans on asset prices that are justified purely on the basis of the ‘greater fool’. Stock and House prices are obvious examples, but this is also the only reason anyone would buy Japanese 30 year paper for the same yield as a 2-year Treasury note – because some other sucker, desperate for somewhere to park his capital will buy. And if all else fails the biggest fool of all - the Bank of Japan will buy it from you.
b) When the asset bubbles burst, they leave behind debt that cannot be paid back, which depresses future activity. This is not new, and there is no excuse for any central planner not to ‘get it’. It was unusually low interest rates that created the housing bubble in the early noughties, which led the the great financial crisis, which led to the slump in productivity we are experiencing now
c) Low interest rates spur all kinds of poor investment choices. E.G.: How much of the junk debt raised to drill for shale would have been issued over the past few years if the money had been borrowed at market rates rather than those encouraged by ZIRP? Answer - much less.
d) In their attempts to create ‘the wealth effect’ and ‘trickle down’, central bankers have created an environment where 'rich insiders' get richer through front running central bank activity; and companies avoid making long-term investments in distorted markets, and buy back their own shares instead
This is the environment our policy makers have created. Is it any wonder that productivity is low? In their attempts to hit the magical 2% inflation, central banks are now onto negative rates. Let’s be clear and honest about this:
(i) QE has not worked; ZIRP has not worked; and so now we’re into NIRP…are you noticing a pattern here?
(ii) Outside of central bank intervention, negative rates are impossible – no free market anywhere, ever, would produce an environment where you loan $100 to someone for a year, in the knowledge that they could go bust, but if they don’t do bust, they’ll return $95 to you next year
(iii) While we do not yet know exactly what unforeseen consequences will come from this, we can say for sure there will be economic distortions
Yet, nowhere in your article is any of this mentioned Mr Wolf. You state the obvious, and you quote a Nobel stating the obvious; but nowhere to you ‘fess up’ to the total pigs ear that our monetary geniuses have made of the global economy these last years. And nowhere do you talk about the things that effect everyday actions and decisions.
If we want higher productivity, we’d better get some business people on monetary policy making forums - because quite frankly I don’t think Professors Krugman and Summers, Doctors Bernanke and Yellen, or Messrs’ Draghi and Kuroda could run a fish and chip shop, let alone understand how to create an environment for people who do.
A fellow reader responded: I know we have been here before, but can you explain how tightening monetary policy results in growth?
Right now it wouldn't - we're way past that.
We've had two decades of easy money and CB intervention at every sign of a downturn, let alone a liquidation. This has produced a massive build up of piles of unsustainable debt, poor investments and legions of zombies. The markets will not return to healthy growth until they 'clear'.
(In the context of forest management they have put out every little fire that would have cleared out dead wood and fertilised the ground for new growth. Now, when the fire does break out, a conflagration event will take place)
The inevitable result of where we have got to is a market clearing event or series of events. This will happen in one or more of the following four 'types':
1. GROWTH - Increased productivity - growing our way out of it. This is not happening which of course is why we're having this conversation
2. INFLATION - Inflate away the debt - this is what they are trying to achieve - it is not working for the reasons I outlined above. BUT - any committed central bank/government can create inflation eventually, though not necessarily control it when they do, as Paul Volcker would explain if any of them talked to him
3. DEFLATION - We have a deflationary collapse - this is what I think will happen initially
4. MONETARY RESET - A global reset of the monetary system, a new Bretton Woods if you will, including debt re-structuring, debt forgiveness, and in my view a radical change to the way governments raise debt through the bond markets
In my view, bearing in mind I don't have a crystal ball, the most likely outcome is:
1. A deflationary collapse in the form of a sovereign debt crisis and carnage in the bond market, followed by
2. Massive government money printing through QE and fiscal means in order to finally get the inflation they need
3. Eventually...when faced with no other choice...the reset will be forced upon them.
So, I'm not saying raise rates and all will be well - it won't. That time was years ago. The guy at the helm at the time was Alan Greenspan, who really knew enough to do far better. But as for this lot, not so much. His problem was hubris, the current crop are clueless.
Fellow reader replied:
Tell me more about 4 - specifically the changes you think are required to the way governments raise debt.
In the US, for example, I think there's two aspects that are corrupt, one centred on the banks, the other on Congress and the special interests that run it:
1. The leverage the primary dealer banks have over the administration - 'who will buy your debt?'
2. The politicians who have mortgaged the future of our grandchildren by borrowing money for guns and butter: to wage wars and pursue 'projects' that line the pockets of vested interests, and to buy people's votes with 'entitlements' collateralised with the future taxes of the 'entitled'.
It's a scam worthy of the mob.
So I believe we need something to keep the politicians 'honest'. The link to gold used to fulfil that function in the sense that they can't print gold, but that was abused in other ways, and historically the gold standard was temporarily dropped during war, e.g. WW1. After WW2 the US gradually eroded its link to gold by the profligacy of its various adventures in Vietnam (guns) and LBJs 'Great Society (butter), ending with Nixon's 'temporary' suspension following a run on US gold reserves led by the French.
So gold may not be the answer, but we need something to keep them honest and prevent them from mortgaging the future productivity of the people on behalf of their cronies - trashing the value of the currency in the process. Debt ceilings haven't worked, so...what next?...
I haven't got all the answers but I think I'm asking the right question.