Illustration: Chaitanya Dinesh Surpur
Societies have always entrusted the task of governance to administrators. In early civilisations, priests donned this mantle, mediating between rulers and their gods. They offered prayers and even undertook the odd human sacrifice to usher in prosperity. Today, the new priest class—financial officials, central bankers and favoured academic advisors—interpret signs from economic and financial gods.
Following the events of 2008-09, politicians facing difficult and unpopular decisions have cleverly passed on the responsibility of the economy to finance officials. Enraptured by their newfound importance, these officials have accepted the responsibility of restoring the health of the global economy. But their efforts increasingly resemble shamanic rain dances and have been unsuccessful in eliciting miracles.
First, these officials have engineered an artificial stability. Budget deficits, low, zero and now negative interest rates, and quantitative easing (QE) have not restored growth or increased inflation to levels necessary to bring high debt under control. Low rates and suppression of volatility encouraged asset price booms in many markets. Some central banks now lower interest rates while simultaneously trying to control rapid rises in property prices by preventing borrowing; this is akin to driving with one’s feet on both the accelerator and the brake. As the inflated prices of many assets act as collateral for loans, central banks are forced to support values because of the potential threat to financial institutions. High prices exacerbate inequality and related social tensions, favouring the asset-owning wealthy classes.
Second, as tried and tested policies lose efficacy, new unconventional initiatives seem to be the risky response of clever but desperate men who have run out of ideas. The actions reflect Spanish thinker George Santayana’s observation that “fanaticism consists in doubling your efforts when you have forgotten your aim”. Central to this is the negative interest rate policy (NIRP), now in place in Europe and Japan. Markets do not believe the NIRP will create borrowing-driven consumption and investment, generating economic activity. Existing high debt levels, poor employment prospects, low rates of wage growth and over-capacity have lowered potential growth rates. The NIRP is unlikely to create inflation for the same reasons, despite the stubborn belief among the economic clergy that increasing money supply can, and will, ultimately create big changes in price levels.
There are toxic byproducts, too. Low and negative rates threaten the ability of insurance companies and pension funds to meet contracted retirement payments. Bank profitability is adversely affected. Potential erosion of deposits may reduce banks’ ability to lend and the stability of funding.
Bank weakness has significant contagion risks. Profitability and solvency issues will affect investors in hybrid capital issues, such as contingent convertible securities (CoCos) and bail-in bonds, which can be converted into equity or written down under certain circumstances. Designed to strengthen banks, these securities merely shift the risk to investors, such as pension funds, insurance companies and individuals.
The capacity of the NIRP to devalue currencies to secure export competitiveness is also questionable. The euro, the yen and the Swiss franc have not weakened significantly to date despite additional monetary accommodation. One reason is that these countries have large current account surpluses—Eurozone 3 percent, Japan 2.9 percent, and Switzerland 12.5 percent of the GDP. The increasing ineffectiveness of monetary policy in managing currency values reflects the fact that the underlying problem of global imbalances remains unresolved.
Third, the manner of policymaking is unconvincing. John Maynard Keynes’s fear that “confusion of thought and feeling leads to confusion of speech” is evident. The US Federal Reserve’s attempt to normalise interest rates has contributed to instability. Speculation, prompted by comments of various current and ex-governors of a delay or halt in rate increases, reversal, a new QE programme or negative interest rates, has compounded confusion.
The European Central Bank (ECB) looks increasingly impotent. Incantations of ‘whatever it takes’, which once had the authority of the holy scriptures, are no longer effective. The ECB has failed to deal with weak banks and over €1.2 trillion of non-performing loans. Instead, it recently called for European Union banking laws to be changed to permit discretionary payments to investors as dividends, bonuses or coupons on CoCos, in cases where it is currently not eligible (if a bank posts losses, for instance). This is odd given that suspension of payments is specifically designed to enhance bank capital in case of difficulties.
The Bank of Japan’s (BoJ) decision to implement the NIRP early last year contradicted statements made only a few weeks before the announcement. The Japanese central bank’s insistence on its ability to launch new measures to reinvigorate the economy rang hollow. The BoJ, which holds around one-third of all outstanding government debt, is currently purchasing more government bonds than the government is issuing. The BoJ also owns around 50 percent of certain segments of the stock market. Government debt is around 250 percent of the GDP, the highest among advanced economies. It is difficult to conceive what more can be done.
Chinese policymakers, until recently applauded as exemplary economic managers, have struggled to tame the country’s stock market slide despite numerous expensive attempts. The People’s Bank of China has also struggled to prevent capital outflows or avoid pressure to devalue the yuan. They have resorted to aggressive market intervention and erratic fixing of the currency designed to surprise and inflict losses on external “speculators”. Facing slowing growth and unwilling to reform quickly, China is oscillating between a strategy of increasing spending and bank lending and trying to rein in high debt levels and financial stresses.
Fourth, despite the International Monetary Fund urging bold, broad measures, the G20 shows little appetite for new initiatives. The weakness in the US dollar following the March 2016 Shanghai Summit led to suggestions that the leading economies had agreed to lower the value of the dollar. This would alleviate pressure on China from a stronger yuan. It would also support commodity prices, assisting lenders who have over-extended themselves providing credit to commodity producers. After a short period of stability, the accord, if there ever was one, seems to have unravelled. At the G7 finance ministers’ meeting in May 2016, Japan clashed with the US on the issue of currency valuation, providing amusing discourses on the semantics of ‘orderly’ foreign exchange markets.
Artificial currency values are ineffective in gaining sustained economic advantage. Japan and the Eurozone benefit from a stronger dollar but the US loses. At the same time, if the euro and the yen weaken, China loses as the dollar rises. Each nation now targets fiscal and monetary policy on domestic objectives, while international cooperation is being replaced by conflict.
Fifth, there is recognition that available options have diminished. In recent months, there have been calls for more coordinated monetary easing, more fiscal easing and more structural reforms to support growth. The prescriptions are familiar. One option, ‘helicopter money’, effectively entails governments to make payments to citizens. But it is merely a novel form of government spending funded by debt purchased by the central bank. It is not clear why these policies, which have been tried repeatedly since 2009, will be more successful this time. Policymakers would do well to pay heed to former British Prime Minister Winston Churchill’s advice: “However beautiful the strategy, you should occasionally look at the results”.
Sixth, policymakers are unable to defend their actions. They rely on contra-factual arguments, asserting that their policies are successful because, in their absence, things would have been worse. The magical thinking combines absolute certainty, a lack of results and weak intellectual basis for the adopted position. Alan Blinder, former Federal Reserve board vice chairman, asserted: “The last duty of a central banker is to tell the public the truth.” Bank of Japan’s governor Haruhiko Kuroda used a Peter Pan analogy to explain Japan’s fight against deflation, arguing that the moment you doubt whether you can fly you cease to be able to do it. Rejecting that options were limited, ECB governing council Lithuanian member Vitas Vasiliauskas stated: “… we are magic people.
Each time we take something and give to the markets—a rabbit out of the hat.”
In earlier times, the inability to deliver a favourable outcome generally resulted in a grizzly end. Today, modern economic priests only face being discredited, losing their celebrity status and access to the halls of power.
Satyajit Das is a former banker. His latest book is Age of Stagnation. He is also the author of Traders, Guns and Money and Extreme Money.