A criminal act

Then again, Bernanke and other central bankers claim that their low interest rate policies have preserved the world from an economic depression. What’s your conclusion when you look back on the last decade since the financial crisis?
I’m of the view that the world-wide suppression of interest rates over the past ten years has been not only inadvisable but, on moral grounds, something very near to a crime.

That’s a tough judgement.
By that I mean that the suppression of interest rates has served to advantage one class of people: The savers have been disadvantaged whereas big banks have been very greatly advantaged, and the financial community has been advantaged. In short: the saver’s loss has been the speculators’ gain. So, the ordinary working person has been disadvantaged and that is apolitical. To speak metaphorically but, I still think truthfully, that kind of policy is bordering on criminal – and I stand by that. [Link]

An important extract from the interview that Jim Grant of the eponymous ‘Interest Rate Observer’ gave ‘Neue Zuercher Zeitung’ in Switzerland.

Misguided answers for wrong diagnosis

A month ago, my friend Manu Bhaskaran asked me for my thoughts on the column by Martin Wolf in FT titled, ‘monetary policy has run its course’. See here. Martin Wolf’s article was a partial analysis of this paper that I have not read.

The article is one of the relatively better ones by Martin Wolf. It acknowledges the problems with monetary policy response to so-called deficient demand, policies aimed at creating ‘conventional’ inflation. Here is the relevant paragraph that most of us can agree with:

If the central bank wants to raise inflation in an economy with structurally weak demand, it will do so by encouraging the growth of credit and debt. It might then fail to raise inflation, but create a debt crisis. That is deflationary, not inflationary.

Thus, the pre-crisis monetary policy, aimed at raising inflation, has now created the opposite: a deflationary debt overhang that works via what Richard Koo of Nomura calls “balance-sheet deflation”. That in turn leads to still lower nominal (and real) rates. Thus, the financial mechanisms used to manage secular stagnation exacerbate it. [Link]

My feeling is that Martin Wolf meant to write ‘post-crisis’ and not ‘pre-crisis’ in the paragraph above. That is a relatively minor issue.

His intellectual dilemma is apparent in the paragraph preceding the above, in the FT article. He disagrees with Claudio Borio of BIS that monetary policy does influence real long-term interest rates. If monetary policy does not influence them, why take so much pains to cut or raise short-term policy rates? Except to those steeped in theory, those who watch the real world will agree with BIS. Incidentally, the BIS paper that Martin Wolf writes also highlights the spillover problem from developed country policies to other countries. Read the following extract from the abstract of the paper:

… external influences on countries’ real interest rates appear to reflect idiosyncratic variations in interest rates of countries that dominate global monetary and financial conditions rather than common movements in global saving and investment. [Link]

While disagreeing with the premise of Borio and BIS, Martin Wolf agrees with the implication that flows from their premise as cited in the quoted paragraph above! You can see his dilemma or contradiction.

Much of the problem lies in defining secular stagnation as deficient demand instead of defining it as a secular stagnation or decline in potential growth. The ‘deficient demand’ school calls for persistent stimulus – low rates, zero rates and negative rates. Now that they have not worked, the clamour has turned to fiscal policy and that is where the ludicrous modern monetary thoery kicks in.

But, before we evaluate the question of whether fiscal policy is the answer, let us acknowledge the full extent of the damage that the misguided monetary policy solution to the wrongly defined problem of deficient demand has wrought.

The problem with monetary policy solutions to the wrongly defined problem of secular stagnation or deficient demand is not just the creation of ‘deflationary debt overhang’ but far worse.

Engineered low interest rates have caused the decoupling of the financial economy from the real economy; have caused asset prices (including real estate and even bitcoin which is not an asset) to decopule from fundamentals (incomes of households and earnings of companies) and have fomented worker angst, income and wealth inequality and have even contributed to the rise of Big Tech and market concentration as cheap interest rates allow technology companies to use the currency of their overvalued stocks to buy upstarts and smother competition.

Fiscal policy, in the Western world, too has its limits. Contingent liabilities and pension obligations are not recognised. If they are added, the fiscal situation is dire. Finland showcases the problem. Read the following extract from another FT article:

The lesson from Finland may be that trying to make health and elderly care costs sustainable involves the types of political choices few governments are willing to make, raising questions about long-term economic growth and the health of public finances for increasingly cash-strapped governments across Europe. [Link]

The clamour for some stimulus or the other will go away if the problem of secular stagnation is correctly defined as the problem of secular decline in potential growth with declining labour force growth and with declining gains from productivity. Much of the technological improvements (you can charge your phone by keeping it on top of mine) are not frontier advancements in nature.

What would the answers to such a problem of a secular decline in potential growth?

Immigration is ruled out because of its political and social effects. Population growth is conditioned on public and private decisions made decades earlier. It cannot be engineered overnight.

Real investments that spark productivity gains are not made easily. Merger and acquisitions, stock buybacks, real estate investment are not the stuff of productivity gains. It is not as though low interest rates are being used to spur investments that deal with climate change. Instead, it is producing the short-term boost to aggregate demand that makes the climate problem worse.

My friend TCA Srinivasa Raghavan, on the evening of the 17th April, shared with me an article that he had written in October 2008. He has been prescient. On deficient demand, he wrote:

Perhaps things need to change now and we need to view macroeconomic policy not merely through the demand prism. After all, 80 years after the Great Depression, a situation of sustained globally deficient aggregate demand, on a scale comparable to the Great Depression, is unlikely to emerge because of three factors: Growth in China and India, the gains in productivity that new technologies are bringing and, of course, the removal of the restraint that Keynes’ ‘barbarous relic’ imposed on global liquidity.

There is really no limit to how much money can be pumped in to restore confidence. In that sense, the Keynesian deficient demand system could have gone past its expiry date. [Link]

His prescience was not just limited to dismissing the deficient demand argument but arguing that growth will be dicated by physical resources (think climate) and asset-price speculation created by excess capital looking for higher returns. If anything, in the last ten years, growth has been driven more by speculation (with all the attendant costs described earlier) than being dictated to by the limit of physical resources.

He anticipated the consequence of such an economic growth process:

Left ideas will begin to look smarter. [Link]

Writing in October 2008, he limited himself to the above extraordinary  one-line warning at the end of the article. Subsequent developments have shown that he has been spectacularly right on the Left!

He agreed that the solutions pursued in the immediate aftermath of the crisis (exemplified by the collapse of Lehman Brothers) were necessary but correctly concluded that the extant macro-economic framework was not equipped to handle the problem.

The solutions pursued in 2008 were not withdrawn in time and were kept in place for too long distorting incentives and much else.

So, are we in a cul-de-sac? Sort of. But, defining the problem correctly will at least avoid running up costs arising from the pursuit of wrong answers. The status quo is worse. We not only do not have answers but central bankers in advanced countries have also compounded the problem.

Redemption starts with acceptance that one has been wrong. Then, minds will open up and right solutions will begin to emerge, even if gradual, to begin with.

Gradual and cautious immigration of the sort that Japan is trying might work. There should be redistribution through higher rates of tax (but not usurious that it defeats the purpose) on higher incomes and through tax on capital gains. There should be some caps on technological developments that raise worker anxiety and lower wages simultaneously. Such technological innovations actually store up much bigger troubles. Business and commercial leadership must lead by example in rebalancing the economy between assets and income and between capital and labour. Finally, may be, the answer lies in higher interest rates!

(p.s: Do read Andrew Smithers’ letter in response to Martin Wolf’s article)

‘Has Asian dominance arrived’ and other links

This Bloomberg story tells us that global debt rose ‘only’ USD3.3trn in 2018 to around USD243trn, about three times the global GDP. If you want to know the background to this news, the link is there in the Bloomberg news-story. It is a research note by the Institute of International Finance.

Despite that, President Trump is not happy with Fed Chairman Jerome Powell. He says he is ‘stuck’ with Powell. This is quite wrong and dangerous. I am surprised at US dollar’s resilience in the face of such gibberish.

According to ‘What we are seeing’ (Edition: 22.03.2019), for the first time, globally, the number of 65-year olds has exceeded the number of 5-year olds.

One has to do more detailed work on the claim that Asia has become the world’s largest economic bloc and that its GDP now exceeds the combined GDP of the rest of the world, in PPP $. My simple response is ‘So, what?’. Of course, I could be very wrong here but the obituatry of Western dominance is being written too prematurely. Asia is at very high risk of internecine warfare and the West has a good track record of ‘divide and rule’. I would like to recall my MINT column from nearly four years ago that the 21st century would belong to the West or to nobody.

This blog post from ‘Bank Underground’ (Bank of England blog) says that rising interest rates increase labour share of GDP because productivity might fall faster than wages do. Or, we can add that capital’s share declines faster in an environment of rising rates due to correction in asset prices. Very interesting and important empirical evidence in this. It shows that a reflexive opposition to higher interest rates by the likes of, say, the Economic Policy Institute is wrong.

SOX and Fed conscience

Record high in the semiconductor (SOX) index (with rapidly slowing end markets for semis and collapsing industry fundamentals)! Extreme (manic) speculation is back. Does the Fed have no conscience? (that’s a rhetorical question). [Link]

That was a tweet by Fred Hickey. I learnt about Fred Hickey from the Global Investment Strategy Weekly of Albert Edwards. Fred Hickey’s tweets also pointed me to the rather shocking slide in the quarterly results of Micron Technologies. See their press release here.

As per this article by Martin Wolf, we learnt that the Federal Reserve has done the following:

We learnt this month that the US Federal Reserve had decided not to raise the countercyclical capital buffer required of banks above its current level of zero, even though the US economy is at a cyclical peak. It also removed “qualitative” grades from its stress tests for American banks, though not for foreign ones. Finally, the Financial Stability Oversight Council, led by Steven Mnuchin, US Treasury secretary, removed the last insurer from its list of “too big to fail” institutions. [Link]

It is a good piece. Worth reading.

This is the actual news-story that Martin Wolf refers to, here.

STCMA – 22nd March 2019

Buying Gold and being bearish stocks is the ‘Trade of the Century’ according to a hedge fund. Personally, I hope they are right.

John Authers defends Jerome Powell for shutting the door on any further rate hike in 2019. I beg to differ. Even if he did not mean to raise rates, there was no harm in keeping markets uncertain. If the Federal Reserve Chairman was worried about a recession, he should also be worried about a stock market that betrays no sign of it. This divergence will make the ultimate pain for the economy all the more longer and greater.

As always, established and prominent figures are dovish in their criticisms of a dovish Fed. Here is Mohamed-El-Erian.

The headline of this article says it all: “Over 80% engineers unemployable for any job in knowledge economy”. If one wished to download the underlying report featured in the article, you can find it here. Have not read the full report yet.

While Martin Feldstein is worried about the looming federal debt crisis, John Authers has a good story in Bloomberg on the 12th March about the corporate debt bloat in the ‘here and now’. The story has many good charts and good arguments (ht Rajeev Mantri). But, John Authers fails to evidently connect this story to his latest missive on the Fed signalling no rate hike. A central bank pre-emptively foregoing its rate increase options does nothing to bring down corporate leverage.

Thanks to my IIM batchmates K.N. Vaidyanathan and Subramanian Sharma, I came across this ‘tweet storm’ or ‘tweet thread’ by Jawad Mian. It is equal to a full credit course on market valuations. It is a salutary lesson in investing at today’s prices.

ECB is back!

So, the European Central Bank made some noise about reversing its Quantitative Easing and ‘Whatever it takes’ policy decisions. After having split open the European Union countries with the consequences of its monetary policy, the ECB has now reversed its stance and has actually announced monetary stimulus today!

So, here is the gist:

Do six years of ‘whatever it takes’;

Threaten for six months to end it, without ending it;

The economy rolls over.

Then, go back to ‘whatever it takes’

That shows the efficacy (or, more precisely, the lack thereof) of their policy. Yet, there are people who do not ask those questions and advocate it (again) and the ECB obliges.

How about this for monetary policy prudence and sobriety?

Still, the ECB refrained from more extreme measures such as restarting its bond-buying program or cutting its deposit rate further from minus 0.4%. These options weren’t discussed, Mr. Draghi said. [Link]

Then, we write tomes on why ordinary folks are angry.