Cries for Going Totally Crazy are Intensifying
What are the basic requirements for becoming the chief economist of the IMF? Judging from what we have seen so far, the person concerned has to be a died-in-the-wool statist and fully agree with the (neo-) Keynesian faith, i.e., he or she has to support more of the same hoary inflationism that has never worked in recorded history anywhere. In other words, to qualify for that fat 100% tax-free salary (ironically paid for by assorted tax serfs), one has to be in favor of central economic planning and support policies fully in line with today’s economically illiterate orthodoxy. Meet Maurice Obstfeld, who has just taken the mantle.
New IMF chief economist Maurice Obstfeld (left) and fellow monetary crank Haruhiko “Peter Pan” Kuroda, governor of the BoJ
Photo credit: Yoshikazu Tsuno / AFP
For all we know the man is merely misguided and otherwise a nice person (in fact, he’s laughing a lot in photographs and seems a personable enough fellow). But his proposals could eventually affect the lives of countless people in the whole world, so he is fair game for robust criticism. We personally believe that he and other members of our “enlightened” technocratic ruling class should resign without delay and start looking for productive work instead of parasitizing and hampering the ever shrinking class of genuine wealth producers, but it seems unlikely that they will be interested in our opinion.
There once was a time when monetary cranks of the sort in charge nearly everywhere today were laughed out of the room. Today they are perfectly free to drive what is left of the market economy over the cliff. Mr. Obstfeld turns out to be yet another in a long list of luminaries belly-aching about (non-existing) “deflation” – this is to say, the alleged danger that the purchasing power of consumer incomes and savings might increase at some point. Allegedly, this remote eventuality has to be guarded against at all costs.
“The Bank of Japan and other central banks around the world may need to try radical new easy-money policies to stave off the rising specter of deflation and revive sickly economic prospects, the International Monetary Fund’s new chief economist warns.
“I worry about deflation globally,” new IMF Economic Counselor Maurice Obstfeld said in an interview ahead of an annual IMF research conference that focuses this year on unconventional monetary policies and exchange rate regimes. “It may be time to start thinking outside the box.”
Weak—and in some cases falling—price growth has plagued Japan, Europe, the U.S. and other major economies since the financial crisis. Plummeting commodity prices are exacerbating the so-called “lowflation” and deflation problems that curb investment, spending and growth.
Surveying several dozen of the largest economies around the world, Mr. Obstfeld said the number of countries experiencing low inflation is rising. Combined with slowing emerging market output, ballooning government debt and monetary policy constrained by the lower limits of interest rates, the deflation risk is fueling fears the global economy could be fast stuck into a deep low-growth mire.
(emphasis added)
We don’t deny that global economic prospects look dim at the moment. However, this is the direct result of the policies Mr. Obstfeld supports and recommends. It has absolutely nothing to do with the fact that government-doctored CPI data are for once indicating a minor slowdown in the pace of inflationary robbery by the State (from the point of view of consumers, price inflation is in essence a hidden tax).
To illustrate how utterly inconsequential the recent slight decline in the rate of change of CPI is in a larger context, consider simply the long term trend in US CPI. We have contrasted it with quarterly annualized GDP growth rates, because they show something important: the steeper the trend in money and credit supply expansion and consequent “price inflation” has become over time, the more real GDP growth has actually slowed (about the only thing GDP data are remotely useful for are historical comparisons and even those have to be taken with a grain of salt: today’s GDP data are actually overstating growth relative to the data employed in past decades). One would expect positivist mainstream economists to take note of such empirical facts and perhaps even wonder if there could be a connection – we have yet to see that happen though.
CPI “inflation” vs. real GDP growth – the blue trend line is mainly meant to serve as a visual aid
An even starker illustration is provided by economic growth in the decades prior to the establishment of the Federal Reserve. We have written about this previously in Presidential Musings About Inequality. Here is the relevant passage:
“[…] the period of the greatest real economic growth in the US, a period that was marked by sharp growth in the real incomes of the broadest possible swathe of the population, was that otherwise dreaded age of the ‘robber barons’, the Gilded Age, in the decades prior to the founding of the Federal Reserve. Prices during that era of extremely small money supply growth were almost continually in a mildly declining trend, thereby inexorably raising the real incomes of workers and the then up and coming middle class. It is interesting in this context to look at the Wikipedia entry on the Gilded Age, which is full of complaints about the poverty of the time and the two crisis that ‘interrupted growth’. At first one gets the impression that it must have been a truly terrible time (even the term ‘Gilded Age’ was actually meant to be sarcastic). However, a few paragraphs in, one finds the following:
“During the 1870s and 1880s, the U.S. economy rose at the fastest rate in its history, with real wages, wealth, GDP, and capital formation all increasing rapidly. For example, between 1865 and 1898, the output of wheat increased by 256%, corn by 222%, coal by 800% and miles of railway track by 567%. Thick national networks for transportation and communication were created. The corporation became the dominant form of business organization, and a scientific management revolution transformed business operations. By the beginning of the 20th century, per capita income and industrial production in the United States led the world, with per capita incomes double that of Germany or France, and 50% higher than Britain. The businessmen of the Second Industrial Revolution created industrial towns and cities in the Northeast with new factories, and hired an ethnically diverse industrial working class, many of them new immigrants from Europe.
Wealthy industrialists and financiers such as John D. Rockefeller, Andrew W. Mellon, Andrew Carnegie, Henry Flagler, Henry H. Rogers, J. P. Morgan, Leland Stanford, Charles Crocker, Cornelius Vanderbilt of the Vanderbilt family, and the prominent Astor family would sometimes be labeled “robber barons” by their enemies. Many of these captains of industry, in addition to building up the American economy, participated in immense acts of philanthropy. Andrew Carnegie, who gave away over 90% of his wealth, said philanthropy was their duty–it was the “Gospel of Wealth”. Private money endowed thousands of colleges, hospitals, museums, academies, schools, opera houses, public libraries, and charities. John D. Rockefeller, for example, donated over $500 million to various charities, slightly over half his entire net worth.
This emerging industrial economy quickly expanded to meet the new market demands. From 1869 to 1879, the US economy grew at a rate of 6.8% for NNP (GDP minus capital depreciation) and 4.5% for NNP per capita.
The economy repeated this period of growth in the 1880s, in which the wealth of the nation grew at an annual rate of 3.8%, while the GDP was also doubled. Real wages also increased greatly during the 1880s. Economist Milton Friedman states that for the 1880s, “The highest decadal rate [of growth of real reproducible, tangible wealth per head from 1805 to 1950] for periods of about ten years was apparently reached in the eighties with approximately 3.8 percent.”
Not so terrible a time after all! […] 1. ‘deflation’ (declining prices) is not inimical to economic growth, as the Federal Reserve and its apologists maintain (the opposite appears to be the case), and 2. the less central economic planning there is and the sounder the money employed, the more economic growth and economic advancement of the poor and middle class strata of society can be expected.
It should actually not be necessary to draw on such empirical examples. One must always keep in mind that economic history cannot possibly replace sound economic theory, as it is always subject to a multitude of interlocking contingent forces and factors. The fact remains however: 1. during the Gilded Age, money was by and large sound, even though the banks operated with fractional reserves (which was the cause of the relatively harmless boom-bust cycles in the period). 2. Moreover, government was but a footnote in the lives of most people. Its spending amounted to approximately 4% of total economic output. It should therefore be no surprise that real GDP per capita has never again grown at a comparably fast pace:
Real GNP growth per capita during the “Gilded Age” – it has never again been greater or more equitable. All of this happened under the dreaded gold standard, with no central bank, IMF or other central planners in sight – click to enlarge.
So what does Mr. Obstfeld’s “radical, thinking out of the box” policy epiphany consist of? It appears he wants central banks to go John Law on us:
“So, what would be thinking outside the box for Mr. Obstfeld? One option is a proposal by Adair Turner, a member of the Bank of England’s Financial Policy Committee, for central bankers to overtly finance increased budget stimulus with permanent increases in the money supply. By contrast, the increased money supply resulting from recent central bank bond-buying programs is meant to be temporary.
In a paper prepared for the IMF conference, Mr. Turner contends Japan will be forced to use such “monetary financing” within the next five years and says the policy should become a normal central bank tool for all economies facing stagnation.
Such an option would be highly provocative to fiscal hawks and those who fear giving central banks too much power, especially when many economists question both the returns and financial-turmoil side effects from existing easy-money policies. The provocative nature of the proposal underscores the extent of the deflation-related anxiety among some policy makers, however.
Perhaps a little less controversial option is for central banks to consider overshooting their inflation targets.
“You can always, always deal with high inflation,” Mr. Obstfeld said. But, “at the zero lower bound, our options are much more limited. In order to bring inflation expectations firmly back to 2% in the advanced countries, where we’d like to see it, it’s probably going to be necessary to have some overshooting of the 2% level, or at least to entertain that as a possibility,” he said.
(emphasis added)
Both of these proposals, namely overt central bank financing of government spending and declaring official “inflation targets” obsolete and aiming for an overshooting of same have been peddled by assorted snake-oil sellers for several years already. It apparently hasn’t dawned on these geniuses yet that neither governments nor central banks can create even one iota of real wealth. If these ideas were implemented, they would transform a budding disaster into an intractable catastrophe – essentially the economic equivalent of an asteroid strike, as opposed to a mere earthquake (see, we always manage to smuggle in an asteroid strike somewhere…:)).
If not checked in time, such extreme monetary interventions can lead to crack-up booms and the eventual collapse of the underlying currency system (the German term Ludwig von Mises used to describe the phenomenon is actually even more descriptive: “Katastrophenhausse”, literally, “the catastrophic boom”). The hubris of today’s planners is evident in Obstfeld’s assertion that it “you can always deal with high inflation”. This is incredibly naïve, and yet, it is a belief that is widely held by our modern-day monetary cranks. They all think they are in possession of an inner Volcker just itching to be released at the critical moment.
What is the end result of a crack-up boom? In the worst cases, the subsequent stabilization crisis can last decades. For instance, the contemporaneous collapses of the South Seas and Mississippi bubbles in England and France in 1722 led to a continent-wide bear market and on-and-off depression lasting 68 years. Half of Europe was instantly bankrupted (in France it was eventually decided to do it all over again by instigating yet another hyperinflation after the French Revolution; the gentlemen responsible were all highly educated and convinced they were on top of things. It would be easy to just stop printing, they eloquently argued).
In the stabilization crisis after the Weimar hyperinflation a number of positive developments were actually discernible initially: for instance, the production structure quickly realigned itself away from the early stage malinvestments of the crack-up boom toward an increase in consumer goods production, with a more sensible production-consumption balance reasserting itself. However, many other symptoms of the final stage of the inflation crisis (such as high unemployment) only improved slowly. Still, considering that the entire banking system had to start from scratch and massive amounts of phantom wealth had to be liquidated, things developed surprisingly well at first.
Unfortunately, the roaring 20s boom was underway concurrently in the US and before the German economy had a chance to truly heal itself, the inflationary boom in the US collapsed, taking the whole world with it. Ultimately the National Socialists took power, establishing their Zwangswirtschaft (aptly called the “Vampire Economy” by Guenter Reimann). This was eventually followed by the most devastating war in history. Ah, but this time “it’s going to be different” of course, because Obstfeld and his central planning buddies have “everything under control”.
The so-called “lowflation” (yes, they even invented a new term for this) that has Obstfeld et al. so exercised – click to enlarge.
Egging Them on From the Sidelines
In case more Orwellian language should be needed to invest this hoary inflationism with new clothes, Citigroup has seen fit to provide it in late September. In an article that appeared at Bloomberg at the time, we were informed that “Citi’s answer to dwindling central bank firepower is ‘Cold Fusion’”. What does “Cold Fusion” mean? Exactly the same – fiscal spending financed by permanent debt monetization. There are a few funny (if at the same time cringeworthy) passages in the article.
First we are told that in order to “create growth”, we not only need more money printing, but more Keynesian deficit spending as well. Maybe this is proposed because it has worked so well in Japan over the past 26 years? Who knows, but all that darn “austerity” must definitely end!
“It’s time for central bankers to ask for help. As the International Monetary Fund prepares to downgrade its outlook for the world economy again, monetary policy makers are running low of ammunition to fight a fresh downturn. Bank of America Merrill Lynch calculates they have reduced interest rates more than 600 times since the 2008 collapse of Lehman Brothers Holdings Inc. with the Reserve Bank of India extending the run on Tuesday by cutting its benchmark more than expected.
While the European Central Bank and Bank of Japan haven’t ruled out buying even more bonds, there are doubts over how much more quantitative easing can achieve given yields are already around record lows and inflation still remains beneath the target of most policy makers. Even easier monetary policy may just end up propelling asset markets rather than economies. That leaves economists and investors increasingly looking toward governments to lead the rescue efforts should the China-led slowdown in emerging markets infect developed nations. BofA Merrill Lynch sees a 25 percent chance of a recession-like slump this year.
“Monetary policy is basically exhausted in terms of producing real growth and even inflation,” billionaire Bill Gross of Janus Capital Management LLC told Bloomberg Television this month. “Fiscal policy is the second piece of the leg that has to take place in order to get us back to where we want to go.”
[…]Austerity is still the order of the day in Europe despite the rise of protest parties and another congressional showdown over debt is looming in the U.S. Gross public debt of around 117 percent of gross domestic product globally versus 81 percent in 2007 may still slow the hand of politicians.”
(emphasis added)
Let us take a brief look at that terrible austerity that is the “order of the day” in Europe.
Europe – a collection of numerous de facto bankrupt states (with the exception of the smaller ones to the left of the chart – several of which are however home to mind-boggling private sector credit bubbles). All this terrible austerity has left the euro zone with record public debt, both in absolute terms and relative to economic output (debt-to-GDP ratio as of the end of 2014: 92.3%) – click to enlarge.
Citigroup’s analysts have correctly recognized that it is difficult for insolvent governments to spend even more. Already a number of them are artificially propped up by the rest, in a comical arrangement that is a bit akin to Worldcom trying to prop up Enron.
So naturally, not only will central banks have to call on governments for help, but the same must concurrently happen vice versa as well. So this is what Citi calls “Cold Fusion”. We think it would be better to call it a high level Three Card Monte (other terms come to mind as well, but are not printable; something involving a circle for instance).
“The medicine may nevertheless need to be stronger than the traditional prescription. If the world economy enters a downdraft, Steven Englander, global head of G-10 FX strategy at Citigroup Inc., proposes a more revolutionary response, akin to the “helicopter money” once advocated by Milton Friedman.
In what he calls “cold fusion,” politicians would cut taxes and boost spending. Central banks would then cover the resulting increase in borrowing by purchasing more bonds as part of a commitment to permanently expand their balance sheets. The easier fiscal policy would be covered by QE Infinity.
“Politically it is difficult for central banks to outright endorse monetization of government debt, but faced with another slump and armed with ineffective policy tools, we expect that central banks will quickly give the wink and nod to fiscal measures,” Englander said in a report to clients last week.
The upshot would be greater purchasing power would be injected straight into the economy, increasing activity and inflation. Long-term bond yields would rise, yet short-term yields adjusted for inflation would turn negative.”
Once again, this proposal is in principle no different from what John Law proceeded to do when confronted with the combination of an exhausted French treasury and a moribund French economy in the early 18th century.
The Nature of the Problem
We will try to lift the veil of economic ignorance attending these proposals a bit further. In an (unfortunately hypothetical) unhampered free market economy, there would be no “economic policymakers”. This would have the great advantage that interest rates and prices would actually be meaningful. In other words, the price signals in such an economy – which one can safely assume would employ sound money – would be genuine instead of being incessantly distorted.
Since gross market interest rates would reflect actual society-wide time preferences (plus an entrepreneurial or risk premium emerging on a case-by-case basis), such an economy would boast of an intertemporally well-coordinated structure of production that would actually be aligned with the wishes of consumers. Businessmen wouldn’t be continually misled by the falsification of prices that results from the manipulation of the money supply and interest rates. As a result, entrepreneurial errors wouldn’t be regularly committed on a system-wide basis (this is not to say that there would be no such errors whatsoever, but there would no longer be enormous capital malinvestment across entire sectors of the economy). In short, this would be the ideal state of affairs.
In the present-day hampered market economy, “normal” boom-bust cycles primarily are the result of the expansion of commercial bank credit to the business sector. Too many of the wrong things will be produced (which ones precisely depends on the discrete points at which newly created money enters the economy, which is mainly a question of contingent circumstances). This is actually the nature of malinvestment: it is not “overinvestment”, it is investment in the wrong lines.
Since real capital is scarce, this implies that too few of the things consumers actually want will be produced concurrently. In practice, a shift of production factors toward more long-term oriented investment projects (the higher stages of the production structure) will occur, while capital maintenance in the middle to lower stages – the products of which are temporally closer to consumption – will be neglected (it is easy to understand why: the lower the time discount, the more the net present value of durable capital goods increases and the more profitable long term investments appear to be).
Consumer demand will actually be higher than indicated by market interest rates, while at the same time, real savings will be lower than indicated by market interest rates: they won’t suffice to sustain and complete all the new long term projects that are undertaken (think of the many half-completed “ghost apartment complexes” left standing in Spain after the real estate bust). Eventually this discrepancy must come to light and a bust will ensue (this moment can be delayed by additional credit expansion, but not forever).
Many businessmen may well be aware of the artificial nature of the boom, but they will still be tempted to go along, either because they believe they will be able to predict its end in timely fashion, or simply because they see no other way of staying in business. However, during the boom, capital will necessarily be consumed. Many of the accounting profits posted during the boom period will later be revealed as illusory and give way to large impairments and losses.
What happens in the event of fiscal deficit spending? Deficit spending tends to lead to intra-temporal distortions in the production structure. Once again scarce resources will be employed in the wrong lines; bureaucrats will simply be groping in the dark and allocate resources without the ability to contrast the prospective results of their investments with the opportunity costs involved. Since all those actually producing genuine wealth have to compete for the same scarce resources, their activities will be necessarily restricted. The outcome is once again a production structure that is out of line with actual consumer wishes. Living standards must necessarily erode relative to what would have been the case otherwise.
A famous real-life example of wasteful government spending: a road to nowhere near Kyoto.
Photo credit: Jeffrey Friedl
Moreover, government possesses no resources of its own. Every cent it spends has to be taken from the private sector, either by means of borrowing, taxation or inflation. Once these funds have been obtained, they are no longer available to the private sector. If one asserts that economic growth can be produced in this manner, one needs to believe that government bureaucrats are better at spending and investing these funds than the people they have been taken from. This belief strikes us as obvious nonsense. Of the three methods of funding fiscal spending, the one now under consideration – inflation – is by far the worst.
However, we can rest assured that the great many private sector cronies infesting our state-capitalist system are salivating over the prospect of arrogating some of this coercively obtained loot to themselves.
Always ready to obtain some of the loot – politically well-connected cronies
As the Bloomberg article notes in passing:
“[…]there is plenty to spend on with the B-20, a group of international business leaders, calculating that 100 million new jobs and $6 trillion of activity could be generated if governments met the infrastructure needs of their economies by 2030.”
There it is again, the infrastructure canard. Building pyramids is also “activity” – but it makes no sense, because it wastes scarce resources. While pyramids, once built, are able to provide monument services, these stand in no relation to the costs involved. These so-called “necessary infrastructure projects” are for the most part no different (Poland’s ghost airports immediately spring to mind).
We have discussed this topic on several previous occasions in the context of the EU’s investment dirigisme (see eg. “EU Planning to Spend Money it Doesn’t Have”, “The Stalinesque 4-Year Plan” and the addendum “Zwangswirtschaft”, which discusses a reader comment on the ominous parallels with Hitler’s economic plan, aiming to make Germany self-sufficient).
The main point is precisely the one made above: investing in such projects necessitates choices. Resources must be withdrawn from other employments or will no longer be available for future alternative employments in the private sector. Since most of these (namely those turning out to be profitable) would have been in line with consumer wants, many of these wants will have to remain unsatisfied. For lack of capital, a number of entirely new products may never see the light of day. It is impossible to gauge the total impact on prosperity and progress, but the cumulative effect over time is presumably quite significant.
Politically well connected cronies will end up benefiting to the detriment of everybody else in society. Relative impoverishment on a society-wide basis is the inevitable outcome – and that is actually the best case. Since the proposal entails financing of deficit spending by the monetary authority with money created ex nihilo, the far greater danger remains though that should it be adopted, the situation will eventually spiral completely out of control.
Conclusion
The fact that the new IMF chief economist is explicitly arguing in favor of policies like so-called “helicopter money” probably makes it more likely that they will indeed be adopted at some point. He is after all a freshly appointed bureaucrat and not a retired one like e.g. Adair Turner, who is merely sniping from the sidelines. Presumably Obstfeld’s opinions also carry more weight than the theoretical proposals forwarded by academics who are currently not in a policymaker role.
It seems unlikely that anything of this sort will happen in the near future, but one only needs to look at how Japan’s policies have evolved over time – over the years, one previous taboo after another was eventually shoved aside by the BoJ in favor of ever crazier experimentation. Note that it wasn’t hindered by legacy legal restrictions either – the laws and regulations were simply altered. This is relevant to the issue, as most central banks are currently not allowed to fund deficit spending by governments directly.
The strength of this prohibition varies between the important currency areas, but one must assume that once the taboo falls in one of them, the others will follow suit, especially when another severe economic bust strikes. As we always say, the lunatics are running the asylum. One shouldn’t underestimate what they are capable of.
The only consolation is that the day will come when the monetary cranks will be discredited again (for the umpteenth time). Thereafter it will presumably take a few decades before these ideas will rear their head again (like an especially sturdy weed, the idea that inflationism can promote prosperity seems nigh ineradicable in the long term – it always rises from the ashes again). The bad news is that many of us will probably still be around when the bill for these idiocies will be presented.
Charts by: St. Louis Federal Reserve Research, Wikipedia, Wall Street Journal, Eurostat
