This Time It’s Different

George Gulino, JHU:

“The four most dangerous words in investing are: ‘this time it’s different.’ ”  -Sir John Templeton

Replace the word ‘investing’ with ‘economic policy’, and the saying still holds true. “This time it’s different” should be the motto of those voices still calling for deeper and more prolonged expansionary monetary policy. They bemoan the deficiencies in the U.S. economic recovery since 2008 and the threat of its unravelling due to exogenous factors such as slowing growth in China. However, they believe that monetary policy has not, as it is usually expected to after a few years, lost most of its ability to address these concerns. The source of this determination to squeeze the bounds of monetary policy is the political dysfunction in the world’s advanced economies that prevents sufficient fiscal stimulus or structural reforms. In the US, for example, both of these alternatives would be impossible to get through Congress for primarily ideological reasons. However, continuing to beat the dead horse of monetary policy in the next few years would be unwise.

“This time it’s different” for monetary ‘doves’ because shiny new policy tools once reserved for charming thought experiments by academics – mainly negative interest rates and helicopter money – are either discussed by policy influencers or are already being used in several advanced economies. Japan, the Eurozone and a few other European countries already have negative-yielding bonds. Negative-interest rate countries represent about a quarter of the world’s GDP and about a third of the world’s bonds at any given time. Federal Reserve Chairwoman Janet Yellen’s offered her take in February, saying, “we’re taking a look at them … I wouldn’t take those off the table.”

Such a desperate last attempt to get people to spend and invest and to force some degree of healthy inflation will not work. With interest rates hovering near zero for the past few years, capital investment by American companies has failed to materialize in the needed quantities. Instead, in many cases, corporations have taken advantage of cheap borrowing rates to fund share repurchase programs that boost the value of their stock. More broadly, low interest rates have contributed to rapid, hardly justified advances in asset markets like stocks and real estate, suggestive of potential bubbles. Meanwhile, Apple found it cheaper in the long run to borrow 6.5 billion dollars in 2014 to pay shareholders a dividend rather than use some of its 150-billion-dollar cash reserves because of high taxes and low interest rates. In effect, savers are being punished by their inability to gain interest on their savings while borrowers are inefficiently squandering their money. To be fair, low interest rates seem to have contributed to the low unemployment rate achieved in the US as well as most of the non-southern-European negative interest rate countries. However, why have they failed to stimulate a satisfying growth rate? Why are companies still not willing to invest, and why is the average worker not demonstrating confidence?

Sadly, investors have been punishing good economic news about businesses and consumers by rapidly selling off advanced economy stocks on the day that it is released. The intuition is that positive economic news could potentially lead to an increase in interest rates. Cheaper money may be able to keep stock prices high on stilts for a while yet, but it cannot conceal the lack of willingness of economic agents to use the money efficiently. To think otherwise is to think that monetary policy can successfully boost aggregate demand, an opinion notably refuted by OECD board member and economist William White. First of all, taking a hammer to banks’ profits in this way diminishes their ability to efficiently allocate resources in the economy. Secondly, the U.S. cannot generate the needed demand given low wages and high debt. Workers’ real wages are too low for them to meaningfully increase their spending, as evidenced by the minimal or delayed impact of low gas prices on consumer spending so far. People are still mostly saving that money or using it to pay down credit card debt, which exceeds $15,762 per U.S. household that carries debt.

What’s really needed is structural reform, perhaps along with a fiscal stimulus focused on infrastructure building and/or reforming the tax code. Across advanced economies since 2008, there has been a loose correlation between freer markets and better performance: hence the US’s relatively good showing compared to the dire state of countries like France and Japan. In the era of Bernie Sanders, anti-trade Trump and a gridlocked congress, however, the political will for making it easier to start and run a business is severely lacking in the US. Lowering taxes, decreasing regulation and improving education are held back by partisan disagreement and sensitivity to special interests. Meanwhile the necessary magnitude of infrastructure building and repair might be too costly considering the nineteen trillion dollars in national debt, evidence of the past and continuing political dysfunction of deficit spending on wars and entitlements. There is also no chance of stimulating the economy by simplifying the tax code or simply cutting taxes until at least after the presidential election, and the budget cuts that might need to follow it would be tough on a fragile economy. Fed reports have implied they are essentially out of policy tools, and that in the absence of real efforts from Congress they must keep interest rates low and explore further measures.

What is a developed, democratic nation to do when its economy is stagnant but it is not willing to change? Negative interest rates have not done much in Europe and Japan, except perhaps besides preventing outright panic. Japanese officials had relied on negative rates to weaken its currency and thus boost exports – only to watch last week as the yen reached its highest value against the dollar in eighteen months. The implied next step, especially being hinted at in a desperate Europe, is helicopter money. Traditional monetary policy is conducted through interest-rate setting, but helicopter money would basically constitute the Fed printing money and handing it directly to consumers. One tame way to do this, proposed by former Fed Chairman Ben Bernanke, is to impose a tax cut and monetary expansion simultaneously. Still, if implemented, helicopter money would likely erode consumer confidence and set a harmful precedent. It would only add to the national embarrassment of our legislators’ inability to govern, which has forced people to keep cash under the mattress so that the bank does not take it. The Fed needs to raise interest rates to some relatively normal level, which would improve confidence and restore some sanity to markets. Before that, however, Congress must start governing.

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