Vivek Kaul
Everything under the sun is in chaos. The situation is excellent.
– Mao Zedong
It has been a little over six years since the start of the current financial crisis in mid September 2008, when the investment bank Lehman Brothers went bankrupt. In the aftermath of the financial crisis the Western central banks went on a money printing binge.
Economist John Mauldin in a recent column titled The End of Monetary Policy estimates that central banks have printed $7-8 trillion since the start of the financial crisis. It is worth pointing out here that this money is not actually printed, but created digitally.
As John Lanchester writes in his wonderful new book How to Speak Money “It’s money that simply didn’t exist before. It’s like typing 100,000 at a keyboard and magically having £ 100,000 added to your bank account.”
Hence, this money is not actual printed money. As Tim Harford writes in The Undercover Economist Strikes Back: “A lot of it is money…not actual printed ‘paper money’ but ‘printing money’ is the simple way to talk about this.”
Once this new money has been created it is used to buy bonds, both private as well as government. This has been done to pump money into the financial system and ensure that there is enough money going around to keep interest rates low.
At low interest rates the hope was that people would borrow and spend more. This would create some demand and help economic growth. But has that really happened? The major creator of new money in the last six years has been the Federal Reserve of United States, the American central bank. It has printed (oops digitally created) around $3.6 trillion of new money since the financial crisis started. And it still continues to do so.
The hope as Henry Hazlitt put it in his book Economics in One Lesson is that “this increased money [will increase]…everyone’s “purchasing power,” in the sense of everybody to buy more goods than before.”
Nevertheless this hasn’t led to a jump in consumer expenditure. Household consumption forms nearly 70% of the American economy. As economist Stephen Roach wrote in a recent column “In fact, since early 2008, annualized growth in real consumer expenditure has averaged a mere 1.3% – the most anaemic period of consumption growth on record.”
This is reflected in the growth of the American GDP as well. As Roach points out “Though $3.6 trillion of incremental liquidity has been added to the Fed’s balance sheet since late 2008, nominal GDP was up by just $2.5 trillion from the third quarter of 2008 to the second quarter of this year.”
Hence, what economists call the “multiplier effect” hasn’t really worked.
The other hope was that all this new money would chase the same amount of goods and services, and this, in turn, would lead to some inflation. As prices would start to rise people would buy goods and services in the hope of getting a better deal.
But that hasn’t happened either. As John Mauldin writes “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.” The inflation in the United States is at 1.7%. This is below the Federal Reserve’s stated goal of 2%.
The only developed country which has managed to create some inflation is Japan. The inflation in Japan is at 3.4%. So has the money printing by Japan managed to create some inflation? Not really. As Mauldin explains “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%.”
Instead of reviving consumer expenditure and creating inflation, all the printed money has been borrowed by institutional investors at very low rates of interest and been invested in financial markets all over the world. Stock markets in various parts of the world have seen huge rallies despite economic growth stagnating. Central banks have hoped that these rallies might lead to a wealth effect. Wealth effect is a situation where the rising value of the financial assets makes people feel richer and hence, spend more money.
But that doesn’t seemed to have worked either. As Roach writes “The operative view in central-banking circles has been that the so-called “wealth effect” – when asset appreciation spurs real economic activity – would square the circle for a lagging post-crisis recovery. The persistently anaemic recovery…belie this assumption.”
This anaemic recovery is visible in the low economic growth rates prevalent through large parts of the developed world. As Mauldin writes “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.”
What all this clearly tells us is that what central banks call “monetary policy” is not working as it is expected to. Investopedia defines monetary policy as “The actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rate.”
The irony of course is that even though the monetary policy is not working the central banks around the world don’t seem to be in a hurry to get rid of it. The money printing programme in the United States has more or less come to an end. Nevertheless, the Federal Reserve has made it clear that it is no hurry to withdraw all the money that it has printed and pumped into the financial system. Hence, it hopes to keep long term interest rates low for sometime.
Other parts of the developed world though are still going strong on money printing. As Ben Hunt, Chief Risk Officer, Salient Partners, wrote in a recent newsletter titled Going Gray “The biggest thing happening in the world today is the growing divergence between US monetary policy and everyone else’s monetary policy. There is a schism in the High Church of Bernanke, with His US acolytes ending the quantitative easing [the technical term the economists have given to printing money] experiment in no uncertain terms, and His European and Japanese prelates looking to keep the faith by continued balance sheet expansion.”
Despite its non-effectiveness, central banks still have faith in monetary policy, as it has been practised over the years. And this might lead to monetary policy totally collapsing in the years to come.
To conclude, let me quote Mauldin: “Sometime this decade (which at my age seems to be passing mind-numbingly quickly) we are going to face a situation where monetary policy no longer works. Optimistically speaking, interest rates may be in the 2% range by the end of 2016, assuming the Fed starts to raise rates the middle of next year and raises by 25 basis points per meeting. If we were to enter a recession with rates already low, what would dropping rates to the zero bound again really do? What kind of confidence would that tactic actually inspire? And gods forbid we find ourselves in a recession or a period of slow growth prior to that time. Will the Fed under Janet Yellen raise interest rates if growth sputters at less than 2%?”
These are questions worth thinking about.
The article originally appeared on www.FirstBiz.com on Oct 13, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)