The intellectual groundwork is being laid for the next stage of the Money Bubble, and it’s going to be epic. Here are excerpts from two articles that appeared over the weekend (and which should be read in their entirety). Both deal with Japan, which went all-in on debt monetization, lost badly, and now needs a new plan.
The first is from a University of Michigan economics professor:
Japan is wasting its time trying to raise inflation.
Japan may succeed at bringing annual inflation up to 2%; indeed, it has made some real progress toward that goal. But suppose Japan succeeds in getting inflation up to 2%; would that be enough? The US economy has struggled mightily despite the fact that it went into the Great Recession with a 2% annual rate of core inflation. Japan could try to target an even higher rate of inflation, as Blanchard, Ball and Krugman recommend, or Japan could leave behind quantitative easing and higher inflation targets to make the leap to next-generation monetary policy.
The key to next-generation monetary policy is to cut interest rates directly instead of trying to supercharge a zero interest rate by raising inflation. Of course, cutting interest rates below zero pushes them into negative territory. But Switzerland, Denmark, Sweden and the euro zone have already shown that can be done. There is a widespread myth that cutting interest rates much deeper than -0.75% would inevitably cause people and firms to do an end run around those negative interest rates by taking their money out of the banking system as paper currency. Not so!
It is easy to neuter cash taken out of the bank as a way to defeat negative interest rates simply by removing the guarantee that the Bank of Japan will take that cash back at face value. This is an idea I have taken on the road that has withstood close examination and grilling by central bankers and economists all over the world. A common reaction is surprise at how easy the practical details are relative to the many much more difficult things central banks already do.
This next one is from Paul Krugman, who’s definitely feeling the momentum shift his way:
…Japan is still caught in an economic trap. Persistent deflation has created a society in which people hoard cash, making it hard for policy to respond when bad things happen, which is why the businesspeople I’ve been talking to here are terrified about the possible spillover from China’s troubles.
So Japan needs to make a decisive break with its deflationary past. You might think this would be easy. But it isn’t: Shinzo Abe, the prime minister, has been making a real effort, but he has yet to achieve decisive success. And the main reason, I’d argue, is the great difficulty policy makers have in breaking with conventional notions of respectibility.
Respectability, it turns out, can be an economy-killer, and Japan isn’t the only place where this happens.
…What’s remarkable about this record of dubious achievement is that there actually is a surefire way to fight deflation: When you print money, don’t use it to buy assets; use it to buy stuff. That is, run budget deficits paid for with the printing press.
Deficit finance can be laundered, if you like, by issuing new debt while the central bank buys up old debt; in economic terms it makes no difference.
Printing money to pay for stuff sounds irresponsible, because in normal times it is. And no matter how many times some of us try to explain that these are not normal times, that in a depressed, deflationary economy conventional fiscal prudence is dangerous folly, very few policy makers are willing to stick their necks out and break with convention.
The result is that seven years after the financial crisis, policy is still crippled by caution. Respectability is killing the world economy.
Both authors make it sound so easy.
What they don’t say is that we’ve arrived at this extraordinary point in history — when helicopter money, negative interest rates and the elimination of physical cash are suddenly mainstream ideas — by following the advice of these guys’ intellectual predecessors.
Their argument, as far back as the 1990s if not the 1970s, has been that it makes no sense for government to allow markets to clear the detritus of bad decisions. Instead, we should just borrow what it takes to satisfy all “needs” and print what it takes to pay the resulting interest. People will buy lots of stuff, “growth” will eliminate all imbalances, both moral and financial, and the system will chug along in equilibrium.
Liking the way that sounded, the developed world broke the link with gold in 1971, started borrowing heavily in the 1980s and bailed out everyone in sight in the 90s and 00s. And here we are, with debts so massive that growth under traditional policy options is impossible.
And right on cue, here comes a new batch of monetary theorists explaining to the ignorant masses that governments just aren’t being bold enough in their borrowing and money printing — and that with just a few little tweaks to our notions of personal freedom (the war on cash) and common sense (greatly expanded government borrowing on top of record debt loads), our problems will vanish.
If this sounds vaguely familiar, it’s because it’s been around in various forms for thousands of years, bubbling up whenever governments borrow and spend themselves into impossible situations. See Rome’s hyperinflation and price controls and John Law’s excellent French adventure.
Another thing the authors omit is the “in a perfect world” disclaimer that should accompany blunt-instrument proposals like sharply-negative interest rates and massive new deficit spending. Here in the real world, where highly-emotional people don’t automatically obey unfamiliar and aggressive government edicts, things tend to spin out of control when markets are hijacked by lawyers and economists.
Anyhow, it’s a virtual lock that some variation of the above will be tried next year in most major countries because it’s the only course of action that doesn’t involve an immediate slide into a deflationary abyss. That it probably leads to something much, much worse will be viewed as a problem for another day.