Dear Ben (Bernanke),
Thank you for your famous blog. A compelling compilation of quaint narrative essays where all the conventions of storytelling: plot, character, setting, and ending, are present. Needless to say, you do experience that special feeling when reading through the specific, and often sensory details, provided to get the reader involved in the conveniently biased sequence of the story.
Fairy tales at their very best. Indeed, I expected no less. You have induced some interesting thinking in some readers. We must be grateful for your efforts to stimulate our minds, even if it comes at the cost of offending our “uncommon sense”.
The first thing that has come to my mind, is the stark contrast between your conduct and that of your predecessor Paul Volcker. You and Greenspan have validated that old latin adage that goes to say “Excusatio non petita, accusatio manifesta”. Funny how Volcker has never felt the urge to talk about his incumbency at the Fed. Okay, to be fair, maybe it’s just that you and the maestro are more outspoken. Perhaps.
And you are smart as well Ben. You sure know how to cover your tracks. Your last post “Should monetary policy take into account risks to financial stability?” is a compendium of self-serving prose. Let me see if I got you right:
1.- The Fed has kept rates low, “conditioned by the great recession”. No previous mistakes at all. No cause effect dynamics between the great recession and previous easy monetary policy. The miraculous “great moderation” that preceded the great recession was awesome, and fully enabled by the Fed. It was just bad luck that the great recession ensued. You don’t know why it happened. Monetary policy had nothing to do with it. It was a black swan. Nobody could have seen it coming. You did not keep rates too low for too long. We are not making the same mistake again.
2.- You, and the Fed, saved America, or at least, in your own words, “Fed policies had a lot to do with that”. And you did that despite the “headwinds” arising from fiscal policy, the financial crisis, and “other factors” (again, none of them your fault). Superman wouldn’t have done better. No mistakes, only action of the right kind, accurately following the Princeton sect manual.
3.- The actual economic environment in the US is excellent, jobs have improved, and the terrible ogre of deflation is under control. Everything is as well as it could possibly be, particularly considering the difficult circumstances that you encountered during your tenure as chairman. Janet should be grateful for the wonderful position she finds herself in. You haven’t painted her into a corner at all. She’s a dove, and ought to feel comfortable with ZIRP anyway.
4.- Best of all, and topping the list, is the fact that Ajello, Laubach, and López-Salido have provided some insight on the fact that monetary policy cannot be used to promote financial stability or pop asset bubbles. Nothing is said about inducing them with excess money and credit creation. After all, monetary policy is, in your own words, a “blunt tool”, and “to the extent that it is diverted to the task of reducing risks to financial stability, (it) is not available to help the Fed attain its near-term objectives of full employment and price stability”. That makes sense because, in the long run, we are all dead, and who cares. So the near term objectives are all that counts. ¿Right?
5.- In truth, you are certain that monetary policy never generates instability and/or bubbles (the subtle implied message reading between the lines), and it is too blunt a tool to help prevent them. Instability just happens to exist, as Minsky said, and we have to use methods other than monetary policy to restrain it as much as possible. And if we can’t, well … tough luck. Again, it’s not your fault (see picture of your favourite pet).
6.- Even if moneatry policy is a blunt tool, it is the tool that God gave you (the last messiah after the maestro), to attain “full employment and price stability”. And, blunt as it is, you nevertheless used it wisely to save America and the world. It is for that reason and no other, that real interest rates below the five year term, have been negative for six years and still counting. But we should not think of you as a cold-hearted individual. You are after all, a compassionate man and feel sorry for retired savers. You and your people at the Fed lament their bad luck. But they really don’t matter because, even in the short run, they will probably be dead. Zero return on their savings will help them get there sooner (and suffer less on their way to the end).
You’ve done very well Ben. I hear you get a six figure number for every event you attend. Make sure you cash in a lot of money. If you live a long live you are going to need it (ask pension fund managers). Unfortunately Ben, one of the consequences of your policies is that it will probably cost you a couple of basis points (see fedspeak for the meaning of a couple) anually, just to remain invested in a portfolio of global safe bonds. More so, if you pay a wealth tax and the depositary. But don’t despair, you will probably make enough money beforehand to account for that.
Brilliant writing. Keep it up. It is always best to suffer martyrdom, than confess to any mischief or wrongdoing. Never do that. Beware of perfection though. Because nobody can be perfect, perfection puts your life at risk unnecessarily. I would recommend you allow for some minor imperfections, like not exercising enough, drinking too much cofee, or the likes. It would be good for your image as well.
And, not to forget, good luck with your equity portfolio if you have one. Hold on to it, you have to help preserve the wealth effect. No rushing for the exits when the time comes please, we don’t need another italian ship captain. Hold on to equities for the long run, and some new chairman will bail you and Siegel out. Trust the Fed.
PD. My wife says I am at times kind of absent, mentally speaking. My reply is that I have to do that every now and then, to try to gain some perspective on these interesting times we are living. Only a couple of days ago, a very close friend and economist, Laura, quietly said: look Ricardo, I have no doubts that this central bank turbo-charged economy is probably not the right model. It certainly doesn’t make sense as a long term model for the economic prosperity of human kind. But, and take this as warm advice, why not consider the possibility that this could go on for a decade or more? By then we will both be retired, and it will be our children’s problem. Why not explore that possibility, and its implications for our lives and our financial investment strategy?
With ZIRP now over six years old, and NIRP increasingly extending its reach, we are going all the way from an “all u can borrow comes free” slogan, to a true “the more u borrow, the more money u make” axiom. The CB’s message to the economic actors is: “Borrow and spend as much as you can, or dare to, and we will pay you for doing just that”. You will just have to remember to pay the waiter (the spread for the bank providing the money, printed by courtesy of the corresponding central bank). No wonder we are bailing out the financial waiter segment. We have also given sovereigns a break. Countries like Germany make money printing bunds. And the CBs pay them an interest for doing so. I would get rid of Volkswagen and Siemens. Printing bonds is a lot more environment friendly. And it is also more self rewarding.
And yet, this bizarro thinking is so extended, that everybody is delighted, and we naysayers are unable to find a reason for this to stop. To be honest, I cannot find a solid answer other than the characteristic “if it can’t go on forever it will stop”. ¿What if it can go on forever, and does not stop? ¿Why not cheer Abenomics and Draguinomics as the latest iteration of the Greenspan saga policies?
Well, in that case, seriously, I have to modify all my thinking. We humans have reinvented the wheel, and I have been dumb enough not to notice. We have a brilliant future, and we are assured to conquer the universe. Restraint will be a term to be deleted from the english dictionary. “All u can eat”, “happy hour 24 hours a day”, and “unbridled sex with everything that has a pulse”, should be the norm from now on. Free borrowing and consequent spending are, after all, a second level byproduct of such atmosphere. A nirvana for many. I doubt it. Yes, it is jesuitic thinking, but I can’t help it. They influenced my education. Mick Jagger would likely suggest free drugs, sex and rock and roll as the way to go. I hope he is right. Money has become the cheapest asset and commodity available.
In this process of free borrowing, that seems to go on forever, it is no wonder we see two clear consequences of, as Jordan would say, “utmost” importance (by the way, astonishingly enough, he is still at the job):
Corollary number one: Debt continues to grow. Should we be surprised that free alcohol for everybody increases the member ranks of alcoholics anonymous? I am not. I do not need to be backed by statistical research, to be certain that a cheap restaurant, with an “all u can eat” business model, increases obesity in the neighbourhood. Over time, they will end up with morbid obesity, in the same way ZIRP evolved to NIRP and it is still an ongoing process.
And debt keeps on growing, big. Corporations have joined the party in a major way. Debt financed stock buybacks are epidemic. 0.6 trillion USD over the last year.Denting away the equity base does not appeal to me as a good idea, but when you force the markets hand, and prices are no longer “market-discovered”, Smith’s invisible hand is nowhere to be seen. Optimizing individual conducts does not produce optimal results for the collectivity. Markets are sometimes disfunctional when trying to ensure that the invisible hand works properly. But when you go for CB directory fixed prices the results are devastating. Politburo directories were more palatable. Think Deng Xiao Ping.
Sovereigns are partying it out. The best thing is, financial literature keeps on talking about recoveries. Take the UK or Spain as the new paradigm. Sovereign debt is above 90% of GDP in the UK, and close to 100% in Spain. Annual budget deficits are in the 5% level (in the spanish case that fails to take into account the recurrent use of social security reserves for an extra 1.5% of GDP). Both have an ageing society with huge unfunded contingencies. They both sport pension and health and welfare systems that are disfunctional and unsustainable. But they are leaving the GFC. Their future is great! Maybe. Agnosticism appeals to me more and more as I grow older.
And, above all, the previous numbers include negligible costs for their outstanding debt, courtesy of ZIRP and NIRP. They seem to count on free money forever. To be precise, I think they are counting on that, for as long as it lasts. They have to know this is a chronic or terminal therapy for our debt illness. They just plan to live with it for as long as it goes.
Corollary number two: The wicksellian, natural rate of interest has been in free fall for the last couple of years. ¿Why? Easy: you increase supply of money abundantly and decrease propensity to consume and invest simultaneously, and voilà, the natural rate of interest comes down in leaps and bounds.
How do you do that in practice?
- First of all, you grow supply. Money printing is easy. Virtual printing presses take care of that. When necessary, you help the printing presses with some extra or alternative credit growth (Chinese style). ¿Tired? Pass the baton to another CB and take turns.
- Second, you must know and accept that propensity to consume will begin a solid downward trend. Easy again. As consumers take on more and more debt, their animal spirits become more subdued. In the same way that marginal utility of any good tends to decrease as the quantity used grows, the marginal utility of becoming indebted to consume dwindles with higher debt levels. Increasing debt levels take care of tapering consumption demand.
- Third, you have to make sure that Capex does not go on a roll on its own, and tensions the wicksellian rate upwards. Easy one more time. Once interest rates have been low for long enough to generate substantial overcapacity in all industries and services, investment will be cooled down. Only productivity related investment will keep up. Money will flow to equities, not capital expenditure.
So it is no surprise that interest rates are going negative further yet. Both geographically (more and more countries join NIRP), and in numerical terms (Swiss and Swedes explore yet more negative interest rates). Low interest rates lower the natural rate of interest. If you are a Princeton sect member, you have to try to keep interest rates below their wicksellkian level to induce credit growth and consumption, so you lower official rates again and again, and rates continue to fall along the curve. The process feeds on itself. indefinitely?
Fisher left a terrible epitaph for himself with his “permanently high plateau” estimate for equity prices. But he was right about this. Low rates beget deflation, and with it, or even before it, lower wicksellian rates. And the process spirals to …. infinity?
I hope infinity is not the outcome for NIRP. I love that Kafka quote: L’eternité c’est long … surtout vers la fin”. Think about it. Infinite is in fact a bad deal for all concepts. Whether it is about drinking, eating, borrowing, or even living. It’s good that there is a limit to everything, even to life.
When one looks at the alternatives to infinite and extensive NIRP, they are unpalatable. By now we have, of course, run out of good alternatives. It is either eternity or a system break up. I look forward to none. The masses are enamoured of the former. Time will tell. In the meantime, why not burn an eternal flame, and keep our spirits up.