Seems like The Economist is doing its part in pushing out the shovel on central banks, similarly to what I did half a month ago. Their take on the matter however is mostly concerned with research about how the zero-bound of interest rates has been mismanaged.
There are a lot of gold nuggets in this article, but the overall ideas that I found to be worthy of taking out of here were predominantly crowding-out effects on government bond issuance, and the desire of pushing investors out the yield curve. Again, looking at this from a physics perspective, this does look a lot like two positive feedback loops coupled to each other, and illustrates even further the need to avoid the zero-bound of interest rates at all costs.
First, there’s the crowding out factor.
First, we get an economic slowdown, meaning capital freezes up in financial circles (particularly if the slowdown follows financial market turmoil, but universally applicable) and risk aversion is high. Thus, risk premia goes up by the risk getting riskier to hold, and by people’s aversion for that risk. Assumptions set. Now follow the logic.
- Issue government debt to spend your way out of this mess (US or Japan really doesn’t have the option of easing taxes compared to a lot of their peers). This follows Keynes 101 and gets capital moving throughout the economy in theory.
- The issuing of said debt spreads the risk premia even further given the availability of government debt, by means of subordinating corporate debt to speculative grade in the eyes of the investors. Why hold expensive corporate debt when there’s so much relatively cheap government debt to park your money with until the times get better?
- Momentum and herd effects take hold of the traders, and pushes this a bit further even, driving corporate debt even further up the yield curve.
- Companies start facing difficulties overall in their funding leading to two double effects: A) if they have cash, they go for putting it in safe government debt, further perpetuating the cycle rather than actively investing it in their (risky) core businesses, or B) if they don’t have cash, they flounder, increasing the risk premia in the market due to contagion and proof-of-risk even further.
- Repeat points 3 and 4 ad nauseam.
Happy, aren’t we? The very policy tool we were supposed to use to get going is really not particularly effective in risk premium areas unless you can actually blanket spray the entire business world with confidence and/or force capital spending to skyrocket. What do we do then?
Second, Welcome to the (un)ctrl+P world!
Yeah, you guessed it, interest rates at zero, and we need further policy easing. Print! But please do not follow the logic set out below:
- Mandarins at the high seat of the Central Bank observe that lending is dead because of a clustering of parked capital in government bonds, due to positive feedback loop 1 above.
- In search of a solution to this, the reasoning goes that they will buy government debt with printed money until it is so expensive (in nominal terms) that no sane person would want to buy them. Read: “pushing investors out the yield curve towards higher yielding corporate debt”.
- The market realizes that bond prices are going even higher, since the buyer of last resort that can print itself back from losses is now buying the asset everyone else wants as well, and enforces PF loop 1…
- …which causes the government to issue ever more debt to stick with Keynes 101 after corporate yield is skyrocketing, going full circle on this entire printing system.
- Thus begins the pingpong-ing of spend-your-way-out and “Press (ctrl+)P to push for yield” between the government and central bank, repeating steps 1-4 of PF loop 2 which feeds off steps 3-4 in PF loop 1.
End result: utter lack of corporate investment and capital spending, velocity of money hits rock bottom with money parked in various non-yielding products for liquidity purposes in the expectation that markets will freeze any moment, leading to total lack of job growth, steady accumulation of government debt and a set stage for ever increasing inflationary pressures as the central banks try their best to buy this government debt.
The one flaw in Keynes 101 reasoning that the article in The Economist addresses? The compound stupidity of central bankers, politicians, and the market cannot be overestimated in the current system. I wonder what the response would be if there simply was a body that was politically independent and was in charge of fiscal policy, much like the central banks take charge of the monetary ditto.
Remedying this situation could of course also be achieved by getting the “not like money” assets some love as TE prescribes, but I still think the notion that we should not avoid the zero-bound at all costs proves itself to be rather absurd. We still have a lot of negative spillover effects before we even get to the disastrous question of just what the central bank should buy to buoy the economy, and what the answer is there is arguably less important than any ideas to avoid asking the question in the first place.