I think this will be the last time I use AEP’s ruminations to get my point across.
Once again. I am not an economist. I am as far removed from academe as is possible. It is just that I find in AEP’s opinions the prevailing attitude that permeates both the wider public and the establishment and as you can imagine I have a bone to pick with both.
Relax, Central Banks Can Still Save Us
Full article with my comments interspersed:
GUIDO: The title is all you need to know. AEP places his entire faith in the banks for the well being of society. He may think Central Banks are a different animal entirely from your garden variety banks, but you and I can see that empirically, they are not. As I stated in previous posts, during the past century banks and governments in the West have successfully introduced the notion that it is the banks that create capital. Here AEP confirms that he either genuinely believes this notion to be true or he perpetuates it by design.
“Even if Europe and America slide back into recession with fiscal deficits already dangerously stretched and interest rates on the floor, financial authorities still have the means to prevent a spiral into debt-deflation.
GUIDO: And this is the question our leaders still have to answer. Why is debt deflation so undesirable? When any official statistic you care to pull up shows that just in the past 40 years in the West debt has grown at a far greater clip than GDP (let alone capital formation), why is the potential reduction in debt so feared? Empirically and mathematically, considering that interest rates “are on the floor” we are already finding it difficult to service debt. Why would more debt be desirable or even a cure? If more debt was a solution than why not just keep piling it on thus obviating the need to work at all?
Whether they have nerve to use those means if necessary, and whether they can overcome deep rifts to act in unison and with overwhelming force, is another matter. It would help if China and other reserve powers stopped sniping from their clay towers. They will suffer just as badly, or worse, if the damn breaks.
Perhaps oddly, I am not as uber-bearish as some at this juncture. It is far from clear to me that the US is crashing into a second slump. While the Philly Fed’s manufacturing index for August was catastrophic at minus 30.7, it is a twitchy index.
Paul Dales at Capital Economics says it flashed false warnings in 1995 and 1998. The US Conference Board’s leading indicators are more reliable. They are signalling sluggish growth.
Andrew Haldane, the Bank of England’s financial stability chief, says global banks have raised equity by $500bn since the bubble burst. They have slashed assets by $3 trillion, and halved leverage ratios from 40:1 to a long-run average of 20:1. “UK and US banks’ cash ratios are at their highest levels for several decades,” he said.
GUIDO: Here AEP quotes Andrew Haldane but since he quotes him, we are given to understand that AEP agrees with the assessment. If memory serves (but am truly unsure and can’t be bothered to look it up because it makes no difference), I believe Andrew Haldane was in the papers some days ago advocating that banks should be allowed to take more risk to save society from implosion… which totally omits to point out that society is imploding because banks have taken risks far greater than their respective national GDPs… but such is the warped logic of the establishment… Regardless! That global banks should have raised equity since the bubble burst is the best we could have hoped for. But what remains a problem is how they have done so if they have done so at all. Last time I checked, banks were still allowed by sundry regulators to disregard a bunch of accounting rules pertaining to mark-to-market. That being so, how exactly did banks raise equity? We all know the answer to that do we not? Public funds… and considering that in the past three years whilst smack bang in the midst of a crisis of historic severity banks have distributed the largest bonuses in history… should we really take what this Haldane character is advocating seriously?
Citizens and firms on both sides of the Atlantic are running a “financial surplus” near 2.5pc of GDP, compared to a 1pc deficit five in 2006. US companies are sitting on $2 trillion in cash. The West is better cushioned this time.
GUIDO: The banks certainly are. As far as the rest of us, AEP or Haldane should check with the 45 million folks on food stamps.
There is much wreckage left, of course. A quarter of US mortgages are under water. A shadow inventory of unsold homes must still be cleared. Detox will be long and painful.
Yet it no longer makes sense to talk of a US housing bubble. The price to incomes ratio has halved to three, among the world’s lowest. Cleveland, Detroit, Cincinnati, and Atlanta are down to 2.4.
But let us concede – as a ‘Gedanken Expirement’ – that arch-bears are right to fear a full-blown global slump. Are we powerless?
The US cannot easily crank up fiscal stimulus with a deficit already at 10.8pc of GDP (IMF estimate). Much as I admire Nobel Laureate Paul Krugman – vindicated in his prediction that US 10-year bond yields would fall to historic lows – he misuses history to argue that spending on the scale of World War Two could safely lift America out of slump.
Yes, the US pushed public debt above 120pc of GDP to defeat Hitler, and Britain topped 200pc defeating Napoleon. Both countries marched on to greatness, but in each case they were the world’s paramount industrial power.
Who was going to threaten US Treasuries or the dollar in the late 1940s when Germany and Japan were under US occupation, and America accounted for half of global GDP?
Military demobilisation allowed an instant cut in the US budget deficit. Today the rot is structural, a failure to stop health care and ageing costs spiralling out of control.
GUIDO: I guess here AEP at least partly redeems himself as even though he may admire Krugman at least he can see through the “utility” of war to kick start an economy.
Have to run now. Will add to my comments later
So with fiscal policy exhausted, the burden must fall on monetary policy. Here we have barely begun to use our atomic arsenal even at zero rates. As Milton Friedman taught us – though nobody in Frankfurt — it is a fallacy to think that low rates are loose. Zero can be extremely tight.
GUIDO: AEP is advocating nagative interest rates. That would be nominally negative rates. Here AEP perpetuates the notion that saving is anathema to a healthy economy. Wealth comes about through spending thus savers and people that do not make use of debt must be punished because they are causing the implosion of the economy. So that if you are a boomer and have just retired with nary a penny to your name, you are supposed to take out even more debt to help the economy along.
That may be the case now with US Treasury yields signalling deflation and M2 velocity collapsing as it did pre-Lehman.
To those who argue that the Fed is pushing on the proverbial string, David Beckworth from the University of Texas replies that the Fed showed between 1933 and 1936 that it could deliver blistering growth of 8pc a year despite debt deleveraging in the rest of the economy.
GUIDO: Assuming that is correct, did that gambit result in a mended economy at the time?
My own view is that Ben Bernanke has strayed from classic Friedman policy, blunting the effect of his two rounds of QE. Under his doctrine of “credit easing” he has steered bond purchases to banks. This has limited effect on the quantity of money.
GUIDO: The Money Multiplier says that money has lost it’s presumed multiplier effect on the overall economy. From this point of view, even more money only debases the currency… which incidentally is exactly what is happening.
A Friedmanite would argue that Bernanke has barely tried monetary stimulus. Yet he has greatly eroded his political capital in the process, especially by arguing that the purpose of QE2 was to push up inflation and help Wall Street. These were tone deaf justifications. “Treasonous” is the verdict of Governor Rick Perry of Texas. That was to be expected, but it does complicate matters.
The eurozone obviously needs looser money. M3 broad money is stagnant and real M1 deposits have turned negative, even in Germany and Holland. Real M1 is contracting at an alarming pace in Italy. EMU growth has wilted, five countries are spinning towards default, and the banking system is seizing up. This cries out for a change of course, yet the European Central Bank is still tightening.
The ECB’s Jean-Claude Trichet said “we do not do QE”. Indeed, Germany forbids it. Not only has the Bundesbank forgotten that the Bruning deflation of 1931 destroyed Weimar – not the hyperinflation of 1923 – it is imposing its policy blunder on the whole currency bloc. The visible result of piling monetary contraction on top of fiscal contraction is to push the Club Med over the edge.
The lesson of 2008-2010 is that further QE by the Fed alone risks a dollar slide and a further global crisis. A successful monetary blitz – if required – would need joint action by all major central banks in concert, including the ECB with no ‘ifs’, ‘buts’, and hostile body language. Some $6 trillion would suffice, or 10pc of global GDP.
We are not there yet. The August squall may pass. US growth may surprise, and China may avoid a hard landing. For all our squabbling, we still live in a benign world where ships and capital move freely and leaders talk to each other.
Remember what the world looked like when Franklin Roosevelt moved into the White House in March 1933 and shut down the US banking system.
The front page of the New York Times on his first Monday in office announced: “Hitler Bloc Wins A Reich Majority, Rules Prussia”; “Japanese Push On In Fierce Fighting, China Closes Wall, Nanking Admits Defeat”; “City Scrip To Replace Currency”; “President Takes Steps Under Sweeping Law of War Time”; “Prison For Gold Hoarders”.
That was a serious situation.”
End of article
GUIDO: In his various incarnations, AEP has been a Monetarist and a Keynesian in equal measure. If not dictated by an agenda, in light of the sheer mountain of incontrovertible empirical and legal evidence that shows the major banks to be at the heart of the problem afflicting us today, AEP’s staunch belief in and support for the centrality of banks in our socio-economic construct has to be admired.
If he is not advocating purchasing sovereign debt a outrance he is pushing for monetary gimmickry that borders on the criminal like negative interest rates. It is hard to believe that professionals of the presumed caliber of AEP, be they pundits, economists or politicians, are collectively unable to draw parallels with the rise and fall of states and societies of the past. Of two things one. Either the people that could make a difference truly believe they can create their own reality, or they are deliberately intent on inflicting the greatest damage on the largest percentage of the population. The third option of course would be that our leaders are incompetent useful idiots. But if one believes in the inherent rationality of man, then one must perforce conclude that it is unlikely that so many leaders could be truly ignorant collectively and simultaneously.
One other thing. In a very recent opinion piece, AEP stated that there is an inherent difference between the fiscal characteristics that apply to individuals and those that apply to the state. AEP made the statement in order to advocate state intervention beyond parameters that would conversely be damaging to individuals. AEP’s thinking appears to go something like this. Individual economic actors have real mathematical and legal limits that they must abide to vis-a-vis making use of debt. Not so the state. And here we can only presume that AEP feels that sovereignty confers to the state the ability to suspend the laws of mathematics (by extension, we must further believe that AEP feels this to be the case particularly if the state in question is the owner of the global reserve currency).
But how can that be possible?
Any state funding must come from individual economic actors. Similarly, the ability of a state to borrow money is predicated on the ability of the members of the state to be economically active.
If economic actors for whatever reason should be unable to maintain the same level of economic activity due to, say, their inability to keep up with current debt service payments, then it is clear that state funding will suffer proportionally more. That is because not only fiscal revenue declines but the ability to sell sovereign debt decreases too.
But, apparently, AEP believes that in this case, the state should just go on to buy its own sovereign debt a outrance and everything will be put right again.
This line of thought of course omits to take into account two basic arithmetical truisms.:
First. If the state is forced to purchase its own sovereign debt because economic actors are unable to make ends meet, then incrementally adding state debt can only result on an even greater fiscal burden on the economic actor.
Second. Adding incremental debt in the absence of a corresponding increase in productive output can only result in debasement of the currency. Debasement of the currency places a further burden on economic actors by needlessly increasing the nominal price level of commodities at a time that economic actors are already struggling to service existing debt.
But I am not an economist. So, what do I know.