Towards the end of April, we discussed how QE has led to a global deflationary supply glut. This is a theme we’ve been building on for a while now and, as noted on Monday, it is perhaps nowhere more evident than among US oil producers. Here is how we have described the dynamic:
The premise is simple. By keeping rates artificially suppressed, the central banks of the world effectively make it impossible for the market to purge itself of inefficient actors and loss-making enterprises. As a result, otherwise insolvent companies are permitted to remain operational, contributing to oversupply and making it difficult for the market to reach equilibrium. The textbook example of this dynamic is the highly leveraged US shale complex which, by virtue of both artificially low borrowing costs and the Fed-driven hunt for yield, has retained access to capital markets in the midst of the oil slump and has thus continued to drill contributing to the very same price declines that put the entire space in jeopardy in the first place. Furthermore, those who have access to easy money overproduce but unfortunately, they do not witness a comparable increase in demand from those to whom the direct benefits of ultra accommodative policies do not immediately accrue.
Global demand, as we’ve seen, is in the doldrums. The evidence is everywhere. Goldman sees freight rates remaining subdued until at least 2020. BofAML notes that the slump in global trade of goods and services has extended into Q2. Perhaps most telling of all, the International Labor Organization blames lackluster global demand for subpar post-crisis employment trends, which in turn has shaved an estimated $3.7 trillion off global GDP since 2008.
Despite it all, the answer is always “not enough Keynes” (more cowbell) which is why we said the following more than a month ago (we also predicted this back in September of 2013):
For those wondering how this will play out, consider that sooner or later, in order to avoid liquidation and stave off severe disinflationary pressures, someone will have to call in "Helicopter Janet" and once the cash paradropping begins well, we'll see you in the Weimar Republic.
Sure enough, the semi-official helicopter cash drop call is here via Bloomberg View’s Clive Crook. Abandon all sound money faith ye who read on:
But QE isn't unconventional any longer. It mostly worked, the evidence suggests. The world avoided another Great Depression. Yet even in the U.S., this is a seriously sub-par recovery; growth in Europe and Japan has been worse still. Now imagine a big new financial shock. It's quite possible that all three economies would fall back into recession. What then?
We don’t like where this is going already, please don’t tell us more…
Sooner rather than later, attention therefore needs to turn to a new kind of unconventional monetary policy: helicopter money…
The idea is far from crazy. Lately, more economists have been advocating it, and they're right.
The logic is simple. If central banks need to expand demand -- and interest rates can't be cut any further -- let them send a check to every citizen. Much of this money would be spent, boosting demand just as Friedman said. Nobody, so far as I'm aware, is arguing that it wouldn't be effective. What, then, is the objection?
One concern is that if a central bank starts giving out money, it will create liabilities with no corresponding assets -- thus depleting its equity. Compare with QE: This also creates liabilities in the form of money, but the central bank gets assets (the securities it buys) in return.
Does it matter that the central bank's equity is reduced? No. Standard accounting terms lose their usual meanings when applied to central banks. Money isn't a liability in the ordinary sense. Nobody is owed and nothing ever has to be paid back. In the same way, a central bank needn't worry about losses, even though accounting "losses" might sometimes arise -- as they also could under QE, by the way. An entity that can create money can't ever go bust.
The real objection is political not economic. Sending out checks is a hybrid of monetary and fiscal policy -- public spending financed by pure money creation. That's why it would work. Politically, this is awkward…
This idea that monetary policy isn't political was never more than a useful fiction. Central banks can't avoid making choices with distributional, hence political, implications. The real case for central-bank independence isn't that monetary policy is non-political; it's that central banks are better than politicians at economic policy.
Today, persistently slow growth and the possibility of another recession call that view into question. Not because central banks have been incompetent or because politicians would do a better job by themselves -- plainly, neither is true -- but because the monetary-and-fiscal distinction no longer works. The useful fiction has become a harmful fiction.
It needs to be addressed. Independence for central banks only makes sense if they have the means to do the job they've been given. At the moment, they're dangerously under-equipped.
The first thing to note here is that the Fed can go broke, it just gets to use the central bank equivalent of a tax loss carryforward to extend-and-pretend.
More importantly, this is all a confidence game in the first place. That is, it's based on human perception and people's expectations. Once you undercut that confidence by doing things like dropping fiat currency out of a metaphorical helicopter, well, let's mix metaphors here and say that the genie is then out of the bottle.
At that juncture, incremental policy maneuvers designed to soak up excess liquidity cannot possibly hope to keep pace with the self-feeding expectations of a public which, while heretofore blissfully ignorant to the futility of QE by virtue of obfuscation on the part of officials ("leave the complicated stuff to us"), will now suddenly understand that the emperor is naked.
Put simply: if printing trillions has so far failed to stimulate global demand and restore robust economic growth, it may be time to admit that the printing press isn't the answer.
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Or maybe not...