The Keynesian PhD Brigade Strikes Again: Sweden's Riksbank Joins The ZIRP Mania

Folks, it's a tyranny of the PhDs. Recently the central bank of Sweden was subject to a withering tirade by that oracle of Keynesian rubbish, professor Paul Krugman, who accused it of "sado-monetarism" for leaving the Swedish economy exposed to the mythical economic disease of "deflation".

So the Riksbank threw caution to the wind, and a few months ago joined the global central bank plunge into ZIRP and promised to ladle out free money until at least 2016. To leave no doubt about its intentions, it is currently cranking up plans for "direct lending", "asset purchases", negative interest rates (N-ZIRP) and the rest of the recently invented central bankers' voodoo kit. Anything to achieve its sacred 2% inflation target!

So still another central bank has been infected by the 2% inflation shibboleth----a folly the greatest central banker of our era dispatched recently with a single sentence:

Mr. Volcker,who believes the Fed’s main goal is to defend the dollar’s stability, said he doesn’t even understand why the Fed adopted a 2% target for inflation. He asked, “Do we want prices to double every generation?”

Yes, today's Keynesian central bankers don't particularly care what happens in the next 30 years or even 30 months. It's all about the noise-ridden "in-coming" data and whether the gap between actual production and employment, one the one hand, and a theoretical figment called full employment or "potential" GDP, on the other, has been closed.

It is downright amazing that the $75 trillion global economy is in thrall to the stupid math models of a couple of hundred PhDs. And these so-called DSGE models (dynamic stochastic general equilibrium) are, indeed,  just plain stupid.

Not a single major economy in the world is a closed system. Nor is the capacity to produce iron ore, petroleum liquids, sheet steel, autos, machine tools, solar panels, networking gear, server farms, e-commerce order fulfillment, warehousing services, quick-serve restaurant meals, shopping boutiques, violin lessons or yoga classes fixed and measureable. Instead, it is a giant, swirling global flux driven by billions of prices and competitive dynamics that continuously bring new capacity into being, put old and obsolete capacity out to pasture and stretch, bend and extend existing "capacity" in ways that are too deep in the economic weeds to observe, measure or manage.

Likewise, the other component of the DSGE---so-called "aggregate demand"----is also a fairy tale. That is, "spending", as it is computed in the Keynesian GDP accounts, and then spit back by the DSGE models which pretend to "forecast" it, is a function of either income or fiat credit.

In a stable, productive and honest  economic system, spending always and everywhere comes from income. Workers earn incomes through the act of production, and then "spend" the major part of it on their current cost of living and save or pay taxes with the rest.

Likewise, businesses distribute some of their net income or profits to shareholders/owners and then reinvest the rest---along with newly raised capital obtained from household savers. Government's also "spend" a fair amount on goods, services and transfer payments, but obtain the financing via levies on the pre-tax incomes of households and businesses.

And that's all there is; there ain't no more in an honest free market economic system. Investment spending is obtained from current savers; debt is one form by which savings are channeled to investors along with equities and various hybrids. Household consumption spending---the famous 70% of GDP---comes from the disbursement of labor and capital incomes to these units; and, yes, when governments run a deficit to finance their spending in an honest system, they tap the savings pool in competition with other investors.

It goes without saying, of course, that in an honest economic system there could theoretically be a lot of debt-----that is, if households were inclined or motivated by high interest rates to save a larger portion of their incomes. The latter increment to the pre-existing savings pool, in turn, could be borrowed by businesses or governments to augment their own spending at higher levels than could otherwise be financed by post-dividend profits or tax inflows, respectively.

An honest "high debt" economy, of course, would reflect the market-clearing price of savings and debt. And, most likely, given human propensity to prefer a bird in the hand to one in the bush, it would mean a high interest rate system----an arrangement that in and of itself would tend to curtail the level of debt.

Indeed, as in almost everything else in economics, high prices (of interest) are the best cure for high debt. But then we come to "fiat credit"----the kind of debt that is manufactured out of thin air by central banks when they purchase existing financial securities---mainly government notes.

Despite all of the gussied-up theories about the function and theory of central banks, the only thing they really do is introduce a deadly economic virus into the system. Namely, debt that is not funded by savings.

Needless to say, the more central banks hit the "print" button, the more the fiat credit disease flourishes, and the greater the distortions in the financial system. Central bank created fiat credit is inherently fraudulent because it amounts to "something for nothing". And, as a practical matter, it causes debt to be underpriced because increasing demands for its issuance do not need to be greenlighted by savers asking for high interest rates in order to defer current spending.

Instead, it is greenlighted by monetary central planners who are inherently prone to an occupational disease. Namely, the unfounded belief that they can generate higher societal growth and wealth by keeping interest rates persistently and systematically below free market clearing levels.

Yes, there is an argument that private fractional reserve banks can create fiat credit, too. But what they really do is more in the nature of "maturity transformation", which means they turn short-term liquid deposits into long-term, relatively illiquid loans. Get rid of deposit insurance, the Fed discount window and the legal shield against fraud suits-----and fiat credit out of the private banking system would not get too far. The high rollers who went all-in making loans and thereby generating "new" deposits would either crash land in insolvency eventually from bad loans; or they would be cut-off at the pass by real savers, who would take there deposits to safer and sounder institutions.

In any event, the artificial boost to credit availability and "growth" in the Keynesian GDP accounts that results from ever increasing amounts of central bank manufactured fiat credit is a one time parlor trick. At length and inevitably, it is stopped cold by the limits of "peak debt".

Suffice it to say, that almost everywhere on the planet that condition has now been reached. The mountainous rise of total credit outstanding---household, business,government and finance--- in the US economy since 1971 is not remarkable merely owing to its magnitude, as shown below.

The more relevant point is that the bottom left of the graph represented 150% of GDP----an aggregate leverage ratio that had prevailed for a century since 1870; and which reflected either the absence of a central bank (before 1914) or the operation of the early Fed which, other than during wartime, was run by people who knew better than to sit around printing money and pretending that they were the masters of the national economy.

At the present time, that ratio is at 350% of national income, and that's "peak debt" for all practical purposes. Try as it might-----and expanding the Fed's balance sheet by 5X since September 2008 amounts to a whole lot of trying---the Fed has been able to only inch total credit outstanding upwards by hardly 2% per year compared to double digit rates which prevailed prior to 2008. That is, when central bankers were indulging in their one-time take-out of the economy's natural debt service capacity against income.

In short, what the recent flattening trend in the chart below really means is that the days of turbo-charging the GDP computations via fiat credit financed "spending" are over. We are back to income based spending. And that condition surely describes most of the rest of the world--but especially Japan and Europe. In short, peak debt means that the one-time Keynesian parlor trick of fiat credit fueled GDP growth is over and done. Accordingly, actual "aggregate demand" today is nothing more or less than the spending that can be extracted from current production; and its particular mix reflects the manner in which the income from current production is whacked-up by households. business and government.

So what you see is what you get when it comes to "aggregate demand". State differently, production comes first, income follows, and spending results. There is no meaningful boost to GDP from fiat credit. It has been a modest sideshow during QE, and now, at least for the moment, there is no boost to income-based spending at all.

That's why the central bankers' DSGE models are a complete crock. There is no measureable or achievable thing called "potential GDP". There is no magic elixir called "aggregate demand" which is different from current production, and which can be goosed and "simulated" by central bankers. And there is no "gap" to fill owing to the ministrations of central bankers running a monopoly printing press.

In other words, DSGE amounts to a foolish kind of bathtub economics. That is, our benighted central bankers believe there is a full-employment line at the top of the tub; and there is a faucet that can be opened to fill that tub to the brim. Their job, they presumptuously aver, is to regulate the water flow through the crude tools of interest rate pegging, yield curve manipulation, wealth effects "puts" and open-mouth word cloud emissions.

Its all bunk, of course, yet bathtub economics is the source of the 2% inflation target. There is not a shred of actual empirical evidence for it. Its just an made-up axiom that purports to explain why there is a "gap" between the imaginary line of potential GDP and actual production, and why more inflation is necessary in order to goose a mythical ether called "aggregate demand".

Indeed, the whole thing completely defies common sense and everyday observation. In a recent post, Mish Shedlock said it well. From Mish

  • If price of food drops will people stop eating?
  • If the price of gasoline drops will people stop driving?
  • If price of airline tickets drop will people stop flying?
  • If the handle on your frying pan falls off or your blow-dryer breaks, will you delay making another purchase because you can get it cheaper next month?
  • If computers, printers, TVs, and other electronic devices will be cheaper next year, then cheaper again the following year, will people delay purchasing electronic devices as long as prices decline?
  • If your coat is worn out, are you inclined to wait another year if there are discounts now, but you expect even bigger discounts a year from now?
  • Will people delay medical procedures in expectation of falling prices?
  • If deflation theory is accurate, why are there huge lines at stores when prices drop the most?
  • (Mike “Mish” Shedlock

And that gets us back to Sweden. Like the rest of Europe, it is suffering from the burden on growth and wealth that accompanies a giant welfare state and its onerous burdens of taxation, regulation and incentives for non-production.

Nevertheless, despite these headwinds, Sweden has experienced a moderate level of real growth (@ 2.5%/year) and a steady 1.5% rate of inflation since the turn of the century. It is not plunging into some economic black hole, and does not face an emergency so severe that it needs to run its printing presses as if there is no tomorrow. Historical Data Chart Historical Data Chart Yet its central bank has not been penurious about expanding its balance sheet, either. The whole "crisis" which caused it to join the ZIRP money printers club is that after a burst of Riksbank credit expansion in response to the financial crisis, its central bankers made a feeble effort to slow things down. Historical Data ChartFor that act of prudence, they were fired. And now the PhD who led the charge, Dr. Henry Ohlsson, is being put in charge.

Ohlsson, also a member of the board of the Swedish Public Employment Service, joins a bank that has lowered its benchmark rate to zero and this week pledged to do what’s needed to jolt the largest Nordic economy out of a deflation spiral........The Riksbank has come under fierce criticism in recent years for cutting rates too slowly to address persistently low inflation, including in June from the Economic Council of Swedish Industry of which Ohlsson was chairman.

So it is a tyranny of the PhDs. It is a group-think mania that has gone global. It's also only a matter of time before the central bankers' money printing spree takes down the very bubble-ridden financial system it has so recklessly spawned.



David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.