Ad Hoc Commentary – Monetarists should sit back and let Keynesians do infrastructure
Larry Summers, perhaps best known for making foot-in-mouth remarks about women while a Harvard president, had recently remarked in polite circles that:
“…we may well need in the years ahead to think about how we manage an economy in which the zero nominal interest rate is a chronic and systemic inhibitor of economic activities, holding our economies back below their potential…”
Usually, one would take such remarks on the impotence of monetarists with a pinch of salt. But given the excitement among pundits (Paul Krugman), and the timing with the congressional hearing on virtual currencies, we should be concerned:
“…US officials at the first-ever congressional hearing on virtual currencies outlined the potential benefits and liabilities of bitcoin…”
We are stuck in a zero interest rate policy (ZIRP). If we count the number of days from dotcom bust to the mortgage bust, and add that number of days to the mortgage bust, we arrive at Jul 2015. If markets panics do indeed move in cycles, then when the next panic hits in Jul 2015, the Fed’s interest rate tool will be impotent. They cannot set rates to negative because that will drive people to hide money under their mattresses.
However, as we noted before:
“In the age of electronic money, you cannot hide.”
Thus, it is likely that the congressional hearings on electronic money have the objective of preventing hoarding when rates go negative. Electronic money and outward capital controls will help ensure that capital stays within the borders and migrate to politically approved products – equities and real estate.
Let us take a step back and explore the most politically convenient economic theories of our time: Keynesianism, and Monetarism. Both seek to eliminate the business cycle via manipulation. Keynesians manipulate demand, while Monetarists manipulate money supply. Today, Keynesians are impotent because they are inhibited by sovereign balance sheets; while Monetarists are impotent because they are inhibited by zero rates.
There is no simple answer here. But if we go back to first principles, we can see some light at the end of the tunnel. Let us start with Keynes. Keynes said to stimulate government demand and reduce taxes. Today, we stimulate government demand but had to increase taxes to pay for it. So, essentially we are taking a step forward and a step backward in the Keynes world. That is probably not the smartest thing to do.
On the Monetarist side, we have reached the zero rates limit. And we are now printing to affect the money supply. However, we are not achieving much inflation because the printed money is used to buy US treasuries (in QE1 and QE2) and Mortgage Backed Securities (in QE3). So, the money is going back to holders of US treasuries (agencies and foreign governments) and holders of mortgage backed securities (banks). When was the last time you heard someone told you that he/she held these securities in their personal trading account? Chances are, all the printed money is stuck at agencies, foreign governments, and banks. Small wonder we didn’t get inflation, let alone hyperinflation. No wonder the Fed wants to taper because printing only leads to more money stuck at high places, increasing future systemic risks, and not going to where it is most required: the real economy. Also, there is no more mileage left in interest rates, and moving it below zero will only destroy both lenders and borrowers. When rates are moved lower, borrowers benefit at the expense of lenders. However, if a heavily indebted government tries to lower the cost of their borrowing by making rates negative, chances are, they will not be able to roll-over their debt to lenders. We can possibly say goodbye to the US Treasury Bills. Of course, the government can always enact legislation to get political-connected holders of capital, say the country’s pension fund to roll-over the debt as part of a national service, but that is another story altogether.
Since negative rates have all the downside of exacerbating the sovereign debt crisis, is there anything that we can do on the Keynes side of the equation? Notice that yours truly don’t even bother to discuss any other economic theories – the reason is simple, nearly everyone in economics today is either Keynesians or Monetarists. The followers of other economic religions are likely closet followers lest they get dismissed as incongruous. The Keynesians can actually fix their incomplete following of Keynes by moving from a strained public balance sheet to a new multi-public-private balance sheet. A multi-public-private balance sheet is a balance sheet supported by multiple governments and multiple private sector lenders. Think of it as a very large investment fund. Using a multi-public-private balance sheet, governments can increase demand without putting all the strain on national balance sheets, and thus national deficits, and thus taxes.
The best mechanism to invoke a multi-public-private balance sheet is via infrastructure investment. And given their stellar reputation as an honest dealer and long track record in infrastructure, the World Bank is best organization for this work. The biggest hurdle to getting this to work is first and foremost political will. However, one can argue that if governments are even willing to consider negative rates, getting US and China to work together to come out with a joint fund might not be that impossible. The next hurdle is the expertise needed to invest in infrastructure is prohibitive to most. This can be solved by clever abstraction by financial engineers. We remember that anyone can drive a car today thanks to clever abstraction by engineers. There will be many hurdles in the lines of national security and so on. However, one can always argue that national security is already compromised today because powerful indebted nations cannot be as independent as they wish due to external creditors. The Syrian debacles and Saudi’s unwillingness to sit on the UN security-council is a case in point.
The cleanest way to make the transition is to perhaps pay back all US treasuries using investment dollars that can only be invested in designated infrastructure bonds. That would solve the problem of compound interest which always destroys debtors, and in turn eventually destroys lenders. We remember the Fuggers, a prominent German banking family in the 16th century, who lost a large portion of their wealth following three Spanish state bankruptcies (1557, 1560, 1575) under the reign of Philip II of Spain.
On markets, yours truly agree with ICahn into the year-end:
“…Icahn warns stock market could face ‘big drop’…”
Good luck in the markets.