The End of Monetary Policy
In today’s Thoughts from the Frontline, let’s explore the limits of monetary policy and think about the evolution and then the endgame of economic history. Not the end of monetary policy per se, but its emasculation.
The End of Monetary Policy Asset classes all over the developed world have responded positively to lower interest rates and successive rounds of quantitative easing from the major central banks. To the current generation it all seems so easy.
All we have to do is ensure permanently low rates and a continual supply of new money, and everything works like a charm. Stock and real estate prices go up; new private equity and credit deals abound; and corporations get loans at low rates with ridiculously easy terms. Subprime borrowers have access to credit for a cornucopia of products.
What was Paul Volcker really thinking by raising interest rates and punishing the economy with two successive recessions? Why didn’t he just print money and drop rates even further? Oh wait, he was dealing with the highest inflation our country had seen in the last century, and the problem is that his predecessor had been printing money, keeping rates too low, and allowing inflation to run out of control. Kind of like what we have now, except we’re missing the inflation.
Let’s Look at the NumbersWhat we find out is that inflation is strikingly, almost shockingly, low. It certainly seems so to those of us who came of age in the ’60s and ’70s and who now, in the fullness of time, are watching aghast as stupendous amounts of various currencies are fabricated out of thin air. Seriously, if I had suggested to you back in 2007 that central bank balance sheets would expand by $7-8 trillion in the next half-decade but that inflation would be averaging less than 2%, you would have laughed in my face.
Let’s take a quick world tour. France has inflation of 0.5%; Italy’s is -0.2% (as in deflation); the euro area on the whole has 0.4% inflation; the United Kingdom (which still includes Scotland) is at an amazingly low 1.5% for the latest month, down from 4.5% in 2011; China with its huge debt bubble has 2.2% inflation; Mexico, which has been synonymous with high inflation for decades, is only running in the 4% range. And so on. Japan is the anomaly. The imposition of Abenomics has seemingly engineered an inflation rate of 3.4%, finally overcoming deflation. Or has it? What you find is that inflation magically appeared in March of this year when a 3% hike in the consumption tax was introduced. When government decrees that prices will go up 3%, then voilà, like magic, you get 3% inflation. Take out the 3% tax, and inflation is running about 1% in the midst of one of the most massive monetary expansions ever seen. And there is reason to suspect that a considerable part of that 1% is actually due to the ongoing currency devaluation.
Inflation in the US is running less than 2% (latest month is 1.7%) as the Fed pulls the plug on QE. As I’ve been writing for … my gods, has it really been two decades?! – the overall trend is deflationary for a host of reasons. That trend will change someday, but it will be with us for a while.
Where’s my GDP?Gross domestic product around the developed world ranges anywhere from subdued to anemic to outright recessionary:
The G-20 itself is growing at an almost respectable 3%, but when you look at the developed world’s portion of that statistic, the picture gets much worse.
The European Union grew at 0.1% last year and is barely on target to beat that this year. The euro area is flat to down. The United Kingdom and the United States are at 1.7% and 2.2% respectively. Japan is in recession. France is literally at 0% for the year and is likely to enter recession by the end of the year. Italy remains mired in recession. Powerhouse Germany was in recession during the second quarter.Let’s put those stats in context. We have seen the most massive monetary stimulation of the last 200 years in the developed world, and growth can be best described as faltering.
Without the totally serendipitous shale oil revolution in the United States, growth here would be about 1%, or not much ahead of where Europe is today.
Demographics, Debt, Bond Bubbles, and Currency WarsDemographics are decidedly deflationary. Every country in the developed world is getting older, and with each year there are fewer people in the working cohort to support those in retirement. Government debt is massive and rising in almost every country. In Japan and many countries of Europe it is approaching true bubble status. Anybody who thinks the current corporate junk bond market is sustainable is smoking funny-smelling cigarettes.
We are seeing the beginnings of an outright global currency war that I expect to ensue in earnest in 2015.
ECB head Mario Draghi is committed to weakening the euro. The reigning economic philosophy has it that weakening your currency will boost exports and thus growth.
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