In a world where economic orthodoxies are being challenged like never before, Scotland has the opportunity to design a system that will be agile enough to deal with the new normal.
In my last two articles, I have questioned orthodox economic thinking by examining why QE did not create inflation and what’s the point of measuring bond default risk using the debt to GDP ratio in our brave MMT world.
(The following extract comes from the minutes of a meeting that took place back in 2012 but I share these same concerns, word for word.).
“I have concerns about more purchases. As others have pointed out, the dealer community is now assuming close to a $4 trillion balance sheet and purchases through the first quarter of 2014. I admit that is a much stronger reaction than I anticipated, and I am uncomfortable with it for a couple of reasons.
First, the question, why stop at $4 trillion?
The market in most cases will cheer us for doing more. It will never be enough for the market. Our models will always tell us that we are helping the economy, and I will probably always feel that those benefits are overestimated. And we will be able to tell ourselves that market function is not impaired and that inflation expectations are under control. What is to stop us, other than much faster economic growth, which it is probably not in our power to produce?
Second, I think we are actually at a point of encouraging risk-taking, and that should give us pause.
Investors really do understand now that we will be there to prevent serious losses. It is not that it is easy for them to make money but that they have every incentive to take more risk, and they are doing so. Meanwhile, we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.
My third concern, and others have touched on it as well, is the problems of exiting from a near $4 trillion balance sheet.
We’ve got a set of principles from June 2011 and have done some work since then, but it just seems to me that we seem to be way too confident that exit can be managed smoothly. Markets can be much more dynamic than we appear to think.
Take selling, we are talking about selling all of these mortgage-backed securities. Right now, we are buying the market, effectively, and private capital will begin to leave that activity and find something else to do. So when it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response. So there are a couple of ways to look at it.
It is about $1.2 trillion in sales; you take 60 months, you get about $20 billion a month. That is a very doable thing, it sounds like, in a market where the norm by the middle of next year is $80 billion a month.
Another way to look at it, though, is that it’s not so much the sale, the duration; it’s also unloading our short volatility position. When you turn and say to the market, “I’ve got $1.2 trillion of these things,” it’s not just $20 billion a month— it’s the sight of the whole thing coming. And I think there is a pretty good chance that you could have quite a dynamic response in the market.
And I would just say I want to understand that a lot better in the intermeeting period and leave it at that.”
Plus ça change
That speaker was Jerome Powell, the current Chairman of the Federal Reserve.
His concerns must be greater than they were back then because all of his predictions have come true:
- QE is now expected to be nearer $10trn, give or take a couple of trillion (!).
- Share prices have been near historic highs with an economic backdrop as negative as ever experienced during this post war period and certainly since the Great Depression of 1929-33. (UK GDP down 20.4% Q2 2020).
- Trying to reduce the size of central bank balance sheets has proven near-impossible to do without frightening the market.
Yet Powell clearly does not make these policy interventions lightly and we should not pretend they are just off-the-cuff.
The Fed has gone from overseeing the market to being the market. That has huge implications for all of us because if the world loses the biggest financial safe haven, there will be disruption beyond what happens in the markets.
The Fed oversees the health of the world’s biggest reserve currency and what happens to the US dollar matters to everybody. If an independent Scotland is to get the best possible start, it has to be designed to be part of the world that it finds itself in.
Quo vadis Scotia?
Does Scotland make the decision that excessive printing of money leads to a devaluation, let alone debasement of the currency, that does not serve the poorest in society?
Would embracing the new central bank norms mean that Scotland should invest in a brave new Green economy financed in a MMT world?
Could Scotland create a super low tax economy in a world where government spending is dependent on central bank interventions and where inflation is curbed not by interest rates but by raising progressive taxes?
Has Universal Basic Income’s time come?
I am inviting the Sceptical Scot community to help develop an understanding of how Scotland could deal with these core questions – and any other fall-out from these historic times.
Fung’s previous two articles: Central banks stumble into MMT; Where has all the COVID-19 money gone?
Further reading:
The Scottish labour market today, Fraser of Allander Institute, August 11
Advisory Group on Economic Recovery report, June 22
Scottish Government seeks validation…, Craig Dalzell, Source, August 6
Image via Wikimedia Commons/Federal Reserve in public domain
Extract taken from Page 192 of https://www.federalreserve.gov/monetarypolicy/files/FOMC20121024meeting.pdf
Joseph MELLON says
We think of money as paper or coins or a number in bank account. It seems very real: no money and you can starve (shamefully also in the UK). Lots of money and you can buy just about anything.
But money is an illusion: it literally does not exist except in our imaginations. It is a promise, nothing more.
Why then are certain few people or institutions the holders of large amounts of promises granted by our collective imaginations?
Because:
– money being literally imaginary (created in our imaginations) is infinitely malleable.
– at some crucial points violence will be brought to bear to support a particular Weltanschauung:
* try moving a hundred homeless people into an unused mansion in London
* try stopping Exxon building a pipeline over your ancestral land
* try leaving Tesco without paying
In each of these cases what is real is the mansion, the land, the food…. and the violence.
The money is purely imaginary.
The ‘economy and the social system as we know it’ is breaking down.
It started to break down in 2000-2008. There are now silly levels of ‘debt’ which cannot be paid. Not repaid, as it was mostly created out of thin air. Debt == money == a promise: nothing more.
So long as everyone believes in the promise, shares an imagination, the system runs on.’
But is the current system, the best we can imagine? No, it isn’t.
What happens when people imagine something better?
In 1989 it was clear the old soviet system in Russia was dead or dying.
Why? Because no-one believed in it any more including (especially) the people who were running it.
Just over 2 centuries ago (not long ago – my grandparents were all born over 120 years ago)
The feudal ‘ancien regime’ ruled in France: it disappeared very rapidly.
20 or 30 years ago it became clear that ‘capitalism’ is dying: surreal financial markets,
supposedly great wealth untaxable on say the Cayman islands, where there is nothing but a few beaches and lawyers offices. The environment is collapsing – and effective action is seemingly impossible.
Ever larger sums are spent on weapons because humanity is apparently in conflict with itself.
Governments have to create ever larger sums of money (make promises that cant be kept) with each successive crisis…
Clowns like Trump and Boris Johnson are elected to the highest office.
That said we think that if ‘the system’ collapses it will be terrible: and it will.
But maybe what comes next will be better: would you want to go back to the feudal system or hunter gathering?
Joe Mellon says
Inflation
– The vast pumping of money into the economy by central banks would normally cause inflation.
So why didn’t it?
Because there are two sorts of money: consumption money and capital money.
Furlough money is being paid to un(der)employed people, but is still is less than their wages: less demand, less inflation. More people are unemployed, which causes low demand not inflation. Companies are not investing. These are all deflationary tendencies: prices stay low for consumption goods.
Inflation for consumption items only happens when:
– they are in short supply and/or
– there is no nominal ‘money’ in the system and/or
– normal people have a lot of loose change and are willing to spend it
The bail out money went mostly to ‘capital’ destinations: the system demands that companies have a believable story wrt. to assets and liabilities or they cannot trade. This was seen acutely in the 2008 bank crisis where the banks balance sheets said they were bankrupt – and should stop trading. So the governments invented money, so bankrupt banks and companies (AIG, Citi, RBS, GM, …) so balance sheets said a company was not bankrupt, and did not need to close. All that moved were numbers: there was no actual economic activity. The governments had said that the fairy tale was real, and most people had an interest in believing it.
This bailout to banks, companies and super rich individuals, led them to having a lot of cash and few investment possibilities in actual economic activity: so they bought back their own shares (hence stock market boom and manager bonuses), and they also bought ‘assets’ things that were as ‘real’ as possible: gold, land, property, businesses.
So: no inflation! (Except in stock market or asset prices for the sort of things very rich people buy: e.g. Picassos, property in New York or London)
So we got crass inflation in ‘capital’ money, asset prices but no inflation in consumer prices (‘consumer’ money).
Joe MELLON says
So what does this all mean for Scotland’s future economic and fiscal policy?
Briefly: the financial markets have completely failed at directing resources to productive economic activity.
They have:
– reduced consumer buying power by inflating the price of housing: people paying 5-10 times the price that was paid even 25 years ago for completely unchanged bricks and mortar had no money to spend on things that actually generate economic activity.
(Contrast Germany where house buying to live in is a minority choice)
– directed investment away from productive companies generating actual economic activity and toward asset speculation (mergers and acquisitions, buy-outs, …)
The priority for a Scottish government should be getting money into the pocket of the normal person: bringing in rent controls as in Germany, ensuring tenant security as in France, generally discouraging house buying, lowering house prices, creating schemes like the public trust housing in Vienna
The second priority should be ensuring that innovative businesses are created and supported. The Irish development agency has vast experience of this in an economic environment similar to Scotland’s. They identified for instance the software industry as vital as early as the 1970’s, and helped create education centres of technical excellence at Trinity and the National Technical University (previously NIHE). Tiny Ireland now has a world reknowned software industry.
Renewable energy is one obvious area for innovation.
A third priority is also ecologically relevant: localising the supply chain, for instance people should be able to eat high quality local food which did not travel round the world. They should be able to source good value products locally: bricks, windows, fences, tools, furniture, artisans, crockery, …
And almost in despair I would add that the Scottish financial industry should try to restore the reputation built up over centuries by companies such as Scottish Widows and Standard Life and so sadly thrown away in a few short years of neo-liberal madness.
Maybe the actuaries and experts of that industry have retained some of their skill and canniness and could help re-invent a financial system that actually worked?
Fung says
Thanks Joe for your contribution.
A part of me thinks that the seperation of monetary and fiscal policy functions has been an accidental enabler for some of the less desirable outcomes since Easy Al turned on the liquidity taps… and everybody else followed.