Vox is a fairly new website with a mission
to not just report the news but explain it. A typical article will lead with
a lot of background, bringing readers up to speed on what the subject is
and why it matters before moving on to current events. All things considered,
this is a great site with a refreshing approach.
But it's not always right. The following article is a backgrounder and opinion
piece on why easy money is a good thing, and why the US needs to emulate
China and throw newly-created currency at stock market corrections and other
intolerable problems. It's well-structured and well-written, and is exactly
the kind of argument that will impress desperate politicians when the current
volatility turns into full-fledged crisis. As such it will provide intellectual
cover for next year's opening of the monetary floodgates:
What
the US can learn from China's response to the stock market crash
There's a lot to criticize about how the Chinese government has handled
the recent stock market turmoil. Over the past two months, Chinese regulators
have banned some executives from selling shares, ordered other companies
to buy shares, and provided government funds to finance debt-funded stock
speculation. Those steps were only going to make things worse in the
long run.
But this week, China's government did something that made sense: It loosened
monetary policy. By flooding the economy with cash and lowering interest
rates, China's central bank hopes to cushion the economic downtown and
hasten a recovery.
Central bankers in the United States and Europe would be well advised
to follow China's lead. They can't do exactly what China did because
interest rates here and in Europe are already at zero. But the US Federal
Reserve and the European Central Bank can and should be doing more to
support economic recovery.
Printing money boosts economic growth
The basic job of a central bank like the Federal Reserve is simple. When
the economy is weak, the bank boosts economic growth by expanding the
money supply. The limit to this strategy is that printing too much money
will create inflation. But in general you should try to boost the economy
as much as possible without creating an inflation problem.
Right now, most economic data suggests that the Fed has been doing too
little to support the economy. Over the past couple of years, the unemployment
rate has fallen to 5.3 percent. That's pretty good, but it could be better.
The unemployment rate stayed below that level for multiple years during
each of the last two expansions. The economy has also been growing at
only about 2 percent per year, below the rate of previous expansions.
THE FED IS DOING TOO LITTLE TO SUPPORT THE GROWTH OF THE AMERICAN ECONOMY
And there's no reason to worry about inflation getting too high. To the
contrary, prices rose just 0.2 percent during over the last year, far
below the Fed's 2 percent inflation target. That's mostly because energy
prices have been dropping, but even if you exclude volatile food and
energy prices, the inflation rate is still a too-low 1.8 percent.
Of course, just because inflation is low now doesn't mean it will be forever.
But fortunately we can also measure market-based expectations of future
inflation by comparing how the market values inflation-adjusted and non-inflation-adjusted
bonds. According to this measure, markets expect the average inflation
rate over the next decade to be below the Fed's 2 percent target:
All of these indicators suggest that the Fed is doing too little to support
the growth of the American economy.
And things are even worse in Europe. While Germany and a few other countries
are enjoying decent unemployment rates, the unemployment rates in Greece
and Spain are reminiscent of America's Great Depression. And inflation
in the eurozone is an anemic 0.2 percent, suggesting that the European
Central Bank could do a lot more to support the economy without worrying
about inflation.
Interest rates are zero, but that doesn't mean central bankers are powerless
Ordinarily, central banks conduct monetary policy by targeting interest
rates. When they want to stimulate the economy, they announce that they're
going to print more money until short-term interest rates fall to a new,
lower level. China did that on Tuesday, cutting a key interest rate to
4.6 percent.
But since the 2008 financial crisis, short-term interest rates in the
United States and the eurozone have been close to zero, leaving little
room for further rate cuts. That has created a misconception that they
can't do more to support economic recovery.
But cutting short-term interest rates is just one way for central banks
to boost the economy. Fundamentally, central banks conduct monetary policy
by creating new money and using it to buy assets. When a central bank "cuts
interest rates," what they're really doing is printing money and buying
short-term government bonds with it. That becomes ineffective once short-term
interest rates fall to zero. But central banks can always buy other assets.
CUTTING SHORT-TERM INTEREST RATES IS JUST ONE WAY FOR CENTRAL BANKS TO
BOOST THE ECONOMY
Indeed, that's exactly what the European Central Bank began doing earlier
this year: It began buying long-term government bonds in a program called "quantitative
easing." The Fed used the same strategy to pull the US economy out of
recession from 2008 to 2014. By 2014, the Fed believed it had done enough
to get the economy growing again, and it halted the program.
But the last year's economic data suggests that judgment was a mistake.
The US economy is still weak, and more stimulus would be helpful. And
while the ECB's bond-buying program was a step in the right direction,
it's becoming clear that it should be doing more as well.
The fact that China devalued its currency earlier this month and cut interest
rates this week provide an additional reason for easier money in the
US. A weaker yuan means that Chinese goods are cheaper in world markets,
making it harder for US exporters to compete. Looser monetary policy
can boost domestic demand, cushioning the blow for US exporters.
The Fed's big problem is political rather than economic
The past year has seen slow economic growth and very low inflation, which
would ordinarily be seen as signs that monetary policy was too tight.
Yet in recent months, the Fed has been debating whether to make monetary
policy still tighter, by raising interest rates for the first time in
six years.
The reason for this is that despite economic data suggesting monetary
policy is too tight, many people believe Fed policy is too loose. Before
2008, it had been decades before interest rates had fallen to zero. And
so people believe that six years of zero-percent interest rates must
be a sign that monetary policy has been dangerously loose.
But the Fed's hawkish critics are mistaken. Six years of zero-percent
interest rates are not necessarily a sign that monetary policy has been
too loose. Indeed, if we want to eventually return to a "normal" economic
environment of non-zero short-term interest rates, the last thing the
Fed should do is raise interest rates now.
Just as 10 percent interest rates in the 1970s wasn't necessarily a sign
of tight money, today's historically low zero-percent interest rates
aren't necessarily a sign of loose money. If money were really loose,
we'd see a booming economy and rising inflation. Instead, growth and
inflation have both been low for the last seven years.
The real (and, alas, obvious) flaw in the inflationist worldview is that the
only true way to avoid the tumult that follows asset bubbles is not to blow
bubbles in the first place. A "throw money at every problem" strategy, in
contrast, only guarantees more and bigger asset bubbles by encouraging excessive
borrowing. Their short-term success plants the seeds of future disaster.
The article also fails to note that we've been following such a policy since
at least the late 1990s when Federal Reserve chair Alan Greenspan responded
to a series of crises in Asia and Latin America (and here, with the collapse
of hyper-leveraged hedge fund Long Term Capital Management) with lower interest
rates and accelerated currency creation. Easy money, in other words.
That this worked in the moment gave credence to the idea that it was good
policy. That it resulted in a ratcheting up of systemic debt that made each
successive bust bigger than the one before was conveniently overlooked. Easy
money advocates seem to take the world as they find it, with the amount of
debt weighing on the system accepted as a given. Instead they should be looking
at how we got here and learning the long-run rather than just the short-run
lessons of past policy choices. Why, for instance, are interest rates already
at zero? Could it be that all the debt we took on to battle previous crises
makes growth under normal interest rates impossible?
Anyhow, Vox's argument is about to win. It will be echoed in the New York
Times by Paul Krugman and others, on Wall Street by the big banks that control
the government (and that literally own the Fed), and by legislators who have
elections coming up (which is to say all of them). By early 2016 it will
be mainstream conventional wisdom, and the resulting easy money policy will
dwarf the QEs that came before.
In so many ways this is shaping up as 2008 redux, only bigger and much, much
more chaotic.
