High time to get real on interest rates

Having just managed to quell a dangerous rebellion among her fellow Committee members, it did not seem the most opportune time for Janet Yellen to start dreaming of the sort of post-war ‘demand management’ that would happily trade a few extra percentage points of price inflation in order to move a little further up the employment axis in that unshakable vision of the Phillips Curve that seems to dominate the modern central banker’s thought processes.

Yet, that is precisely what she did, shortly after that contentious meeting had broken up.

‘If we assume that hysteresis is in fact present to some degree after deep recessions, the… might [it] be possible to reverse these adverse supply-side effects by temporarily running a “high-pressure economy,” with robust aggregate demand and a tight labour market… if strong economic conditions can partially reverse supply-side damage after it has occurred, then policymakers may want to aim at being more accommodative during recoveries than would be called for under the traditional view that supply is largely independent of demand.’

The principal question that arises on reading this blinding revelation is what on earth does she think the Fed and its camp followers abroad have been doing all these years?

But beyond that, it really is dispiriting to see the myth that one can simply trade off price inflation for employment still informing most current central bank discourse.

To the degree that this empirical finding points to any deeper truth at all, it can only be in the context where organized labour is sufficiently powerful both to make insupportable wage demands of employers and to inveigle the state into printing enough extra money to prevent their grant from pricing the unionized out of work in the private sector and to facilitate the financing of subsequently swollen budgetary expenditures in the public one.

The Bank of England is another classic case in point. Take the lesser of its two Goldman, Sachs alumni, Ben Broadbent, another man given to harping on about ‘uncertainty’ without ever wondering if he and his colleagues might be adding to it.

He told his interlocutor on BBC Radio a few weeks ago:

‘If we had wanted to ensure that we set policy – the level of interest rates – in such a way as to ensure there was no chance of it rising above target, then we would have had to have set tighter policy. That would have meant lower economic growth and that would have increased the chances of unemployment going up.’

Apart from being another clear instance of the Phillips Curve fixation at work, this surely also represents a rather startling dereliction of the Bank’s duty to stick to the sacred mandate whose attempted fulfilment is its first, last, and only line of defence against its growing army of external critics.

But the palm must inevitably go to the more senior of the two Goldman old boys, for, in a burst of wild self-glorification, Governor Carney has even claimed that he has prevented the recruitment of a ghostly ‘industrial reserve army’ of jobless with the sterling-sapping machinations he enacted in August.

‘We took a decision that it was better not to have another 400,000 or 500,000 people unemployed in order to get inflation right back to target at exactly two years. That was a trade-off that we took,’ Ole ‘Forward Guidance’ himself told a mid-month Birmingham audience.

Before a House of Lords committee, he went further, listing the improvements seen since the Crash – the 2.6 million new jobs (actually, a lesser 1.9 million above the old peak and still 1.2 million below the projection of the 1993-2007 trend); the 16% rise in GDP (still 11% below an extrapolation of 1960-2007’s log trend and growing at 2.1% p.a. versus that trend’s 2.6%); and the 9% rise in per capita income (though only 2.2% in real terms from 2007’s levels) – before admitting, with more than a hint of false modesty, that not all of that was due to his policies alone. At the same time, he had the temerity to declare that their positive impact was ‘without parallel’!

With that hubristic assertion, it may be that we have just witnessed Peak Central Banker, my friends.

It’s not my fault!

Back in the US, as a follow-up to Yellen’s typically sophomoric ramble, the great wise owl of central banking, Stanley Fischer himself, next got up to enlighten us mere mortals as to how he and his fellow Olympians view our petty, little world of human affairs.

To begin with, he elucidated what he saw as the three main problems with low interest rates. The second and third of these can be easily dismissed, so we deal with them here first.

‘…low interest rates,’ he tells us, ‘make the economy more vulnerable to adverse shocks that can put it in a recession. That is the problem of what used to be called the zero lower bound on interest rates. In light of several countries currently operating with negative interest rates, we now refer not to the zero lower bound, but to the effective lower bound, a number that is close to zero but negative…’

Yes, Mr. Fischer, but why are they so close to your threshold of catastrophe? Because you and your predecessors have spent a quarter of a century – arguably the whole 30 years since the Crash of ’87 – driving them there. In that time, you have all assiduously practised Greenspan’s indulgent aunt policy of refusing to address obvious early signs of monetary laxity during the seductive efflorescence of a Boom which it is your self-exculpatory dogma to deny you can ever identify; of vigorously ‘mopping up’ and so institutionalizing moral hazard when it inevitably bursts; and then of pussy-footing in the subsequent restoration of more normal settings – and, worse, of doing this to a monotonously predictable schedule of baby-steps lest you ‘surprise’ the market.

What you and your kind overlook here is that this latter affectation – born one presumes from that persistent and widespread misreading of the history of the Great Depression which I term ‘The Ghost of ‘37’ (q.v.) – is nothing more than a speculator’s charter combined with a gilt-edged invitation to misallocate capital and so to ensure the seeds of the next Boom-Bust cycle are sown in fertile ground.

Your chief, Mme. Yellen, may love to sound all pseudo-scientific with her allusions to the concept of ‘hysteresis’, as we have seen above, but here is the REAL hysteresis: that of the recurring, central bank-facilitated wastefulness which is induced by those interest rates which you and your infernal ‘models’ seek to impose on the free market for capital and which display a deplorable proclivity to err on the side of ease.

It should surely not be beyond the wit of the Professoriate which now rules over us to recognise that its increasingly panicky efforts to cushion the immediate effects of that mass economic recalculation we call a ‘recession’ – coupled with its poltroonery in refusing to allow rates to rise rapidly enough in its aftermath so that the foundations of the recovery may be more solidly anchored in a more properly-priced capital bedrock – are the very wellspring of our problems.

Too much debt, at too low a price in relation to both the present and the foreseeable future provision of resources, is encouraged in the upswing. Then, too much of that crumbling mountain of obligation is cemented in place once the impossibility of fulfilling its contractual terms of service becomes generally apparent. Policy then becomes reduced to the crass reckoning that if the product of principal times interest is to be bearable in a world where that principal must never be allowed to shrink, then interest must be forced successively lower and the malign, longer run consequences of that distortion, go hang!

Fischer bewails the increased vulnerability of the ‘economy’ – to lapse into the use of such a gross aggregative personification for a moment – but the man cannot seem to grasp that lower rates do not ease, but rather perpetuate this by increasing the attractions of debt and by lowering the incentives to save (i.e., by lessening the appeal of having a reserve with which to weather the vicissitudes of life and so to reduce ‘vulnerabilities’).

Those who DO nevertheless wish to save are then forced to disembarrass themselves of the surplus monies whose creation has been the primary means for depressing rates by seeking outlets whose values are far less reliable than they or their trustors can comfortably bear. Faute de mieux, this takes the form of the incurrence of extra maturity risk, credit risk, currency risk, or of hazarding the greater economic fragility of holding part of an increasingly thin, debt-eroded veneer of equity (or, indeed, some other, more directly leveraged form of investment) in place of a more dependable, prior claim on their obligor’s income stream.

Worse yet, with a circularity of logic which speaks to either the cynicism or the unworldliness of its proponents – Fischer among them in this very same address – this state of affairs is sniffily condemned by those who have brought it about as a ‘search for yield’ and the anxious disposition of the vast monetary flood they themselves have purposely unleashed is cited as evidence of a ‘savings glut’ and thus as justification for even lower rates!

In his speech, Fischer’s first avowed ‘problem’ with low rates is the ‘possibility that they are a signal that the economy’s long-run growth prospects are dim’. But are they dim because you insist on keeping rates low, you might ask yourself, Stan?

Avoiding any such hint of self-examination, in its place we get the usual rehearsal of all the wearisome 19^th-century maunderings – so beloved of Marx, among others – of how we are so sated with capital and so starved of employment for it that we can no longer earn any appreciable return in its use. What a veritable earthly Paradise it must be that we inhabit. One wonders why life in this Utopia is the occasion for so much gloom and doom.

Mix this in with the fashionable reverse Malthusianism of demographic dwindling and we are back with that rehash of the Dismal Keynesian prognosis of ‘secular stagnation’ conceptualized by Alvin Hansen in the late 1930s and so irritatingly proselytized today by Larry Summers.

First as Tragedy; Then as Farce

Here, we beg the reader’s indulgence to engage in a lengthy quotation:

‘Formerly youthful, vigorous, and expansive, the American economy has become mature. The frontier is gone. Population growth is tapering off. Our technology, ever increasing in complexity, gives less and less room for revolutionary inventions comparable in impact to the railroad, electric power, or the automobile in earlier times.’

‘The weakening of these dynamic factors leaves the economy with a dearth of opportunity for private investment… saving accumulate inexorably… and pile up as idle funds for which there is no outlet in physical capital… setting in a downward spiral of income and production.’

‘…the mature economy thus precipitates chronic oversaving and ushers in an era of secular stagnation and recurring crises from which there is no escape except through the intervention of government which must either expand public investment or tax out of existence the excess savings which are poisoning the economy.’

‘In short, the private economy has become a cripple and can survive only by reliance on the crutches of government support.’

An editorial in today’s Economist? A leader in the New York Times? A commencement speech from the podium at Harvard?

No. The extract comes from a 1945 work by an economist working outside the ivory tower called George Terborgh who systematically debunked what he rightly derided as the ‘romancing’ and ‘soothsaying’ of the contemporary stagnationists in his book, ‘The Bogey of Economic Maturity’.

Despite its vintage, and aside from the technicality that such doom-mongers’ grandchildren would now destroy ‘idle’ savings by means of negative interest rates, rather than explicitly through taxation, it is hard to tell the difference – right down to the sudden, near-universal springing-up of the idea today that those poor, ickle-wickle central bankers are becoming ‘overburdened’ in trying to restore prosperity and that these failing Titans now need the politicians – from whom they are of course inviolably independent– to step up and waste (sorry, invest) some of those stubbornly surplus cash balances.

In the rhetorical crescendo of Fischer’s speech, we get exactly this appeal to those severe practitioners of fiscal austerity to whom the previous formula had been monotonously addressed that they were being bought time to engage in ‘structural reforms’. Now, it seems that our noble representative – elected or, in the EU’s case, largely not – is now to be exhorted to rush out and buy votes, placate unions, and generally make expensive nuisances of himself by indulging in an orgy of (no doubt fashionably ‘green’) infrastructure boondoggling.

Here, too, is a curious pot-pourri of analysis. Keynes – the man who often (though typically not consistently) argued that savings and investment were identical – is lovingly referenced, yet the argument is advanced that the two activities have somehow become imbalanced.

Next, we hear the exhortation for the government to raise the ‘equilibrium’ rate, by spending up to the ill-defined limits of its ‘fiscal space’, mixed with the argument that hurdle rates are currently anomalously low and, implicitly, that this means we can afford the state to indulge in making its own characteristically dubious contribution to greater productivity – i.e., that we can allow it to crowd out all potentially more viable uses of capital.

As a not very convincing rider, we then get the standard disclaimer that these projects should be selected (the ‘how’ or the ‘by whom’ is conveniently never made manifest) so as not to ‘challenge long-term fiscal sustainability’ but instead to ‘boost the economy’s long-run growth rate’. Advocates of the Hayekian concept of the Knowledge Problem obviously should look away now, as should proponents of Buchanan’s withering Public Choice strictures.

Unspoken in all this is the fact that Fischer’s treatment embodies that age-old fallacy – the productivity theory of the interest rate. This is a mistake which assumes that the ratio between the current price of a resource and the cumulative income it is estimated to throw off (plus any residual sale value it will attain) in the hereafter is what determines the price one will pay for the rent of the necessary funds to buy that resource.

Draghi, in a speech which was in suspicious accord on all it main points, stumbled into this same blind alley in explaining what he described as a ‘worrying’ fall in real yields:

‘…a secular slowdown in productivity growth across advanced economies, coupled with pessimistic expectations about growth potential in the years to come, which has reduced the expected rate of return on capital. And if that real rate of return falls, it is logical that firms will only be willing to borrow at lower real rates. This is reflected in lower long-term real yields.’

Shovel-ready Shamanism

The error lies in not stopping to wonder why the equation does not, in fact, run in reverse such that the estimated NPV of those same future cash flows – after discounting by an interest rate set exogenously to this reckoning (explicitly, through the expression of societal time preference) – is what sets the price of the current menu of inputs needed to generate them.

It thus neglects the simple truth that the richer we are – i.e., the more physically prodigious are our joint works – the more readily our basic needs are satisfied, the lower the marginal utility of the next batch of goods which could be devoted to today’s satisfaction and, hence, the less impatience we suffer in harvesting the slower-ripening fruits of putting them to tomorrow’s less pressing uses. In other words, the more prosperous we become and the more ‘coherent’ is the ordering of our material

efforts, the lower the natural interest rate should be.

Thus, its naturally occurring decline is not a sign of our malaise, but a testimony to our sound, bourgeois endeavours.

That higher equilibrium rate of which Mr. Fischer et al are so desirous is thus founded upon some highly doubtful premises but, furthermore, it seems to represent a cart-before-the-horse confusion almost as bizarre as that which informs the present pursuit of price inflation as an end in itself.

If, in Mr. Fischer’s mind, greater productivity and increased prosperity are necessarily accompanied by higher interest rates, he seems to be arguing here that the converse necessarily applies; that higher interest rates are accompanied by greater productivity and increased prosperity – so long as they are delivered by others’ fiscal, and not his monetary, intervention, at least!

In itself this is a strange volte face for what we have been told is the mainspring of all the trillion-dollar enormities of QE, QQE, and NIRP up to now, is that to lower real interest rates on the supply of credit, we must do everything we can to raise people’s inflationary ‘expectations’, if not actual price inflation itself. Now we are to abandon trying to capture that particular Cheshire cat grin and to emphasise in its place the need to jack up the real rate on the demand side by building ‘two pyramids’, singing ‘two masses for the dead’, and, if not ‘two railways from London to York’, at least one highly unnecessary HS2 line from London to Birmingham.

Missing in all this theorizing is any consideration of why it is that if a higher degree of physical productivity is indeed realized (i.e., if we can cleverly arrange to get more widgets out per thingamabob in), the aggregate sales proceeds associated with that expanded production should ever rise at all – and hence whether we can justify any extra outlay of pecuniary interest – if there is no concomitant monetary inflation to increase the means with which to buy them and so support their unit price in defiance of our ingenuity.

Here, as Dennis Robertson pointed out eighty-odd years ago, if that price support does eventuate, the monetary authorities are first ‘burgling’ the employees whose real wages do not rise as they should and then fencing the proceeds to their employers whose profits are thus artificially boosted in proportion.

As an aside, Robertson noted that the necessary corollary of this surreptitious redistribution of purchasing power in the Roaring Twenties was the rapid take-up of the then new-fangled institution of ‘hire purchase’ – the first instance of the extension of mass consumer credit. In that way, as he noted, what Benjamin Strong’s Fed took from the worker was subsequently lent back to him so that he might yet buy the product of his and his fellows’ prolific toil.

What Robertson did not point out was that this hidden form of inflation – a monetary expansion which did not so much boost prices as prevent them from falling naturally – not only increased personal ‘vulnerability’, to use Fischer’s nomenclature, but fostered a wild entrepreneurial over-ambition, too, right up until the moment the whole euphoria was violently dissipated amid the whirlwind of forced liquidation which was Black Tuesday, October 29^th, 1929.

So ended the first great experiment with the criterion of ‘price stability’.

The Last Man in, Turn ON the lights!

The final pillar on which central bank Groupthink now rests is an appeal to demographics and to the irritating tendency for those approaching retirement to save and not to spend – which is, of course, little more than the old Keynesian underconsumptionist ‘paradox’ dressed up in beige cardigan and slippers.

What again is overlooked is that if the superannuated are to have any capital to draw down upon, they must first build it up, and that if they will soon have less income on which to support their debts, they must now try to pay them off – a process of which Draghi, by the way, emphatically disapproved in his Berlin presentation.

Needless to say, this recent focus on the gerontification of the world brings with it its own caravan-load of ironies and inconsistencies – not least from the soi-disant ‘Progressives’ who at once tear their hair at shrinking national product and gnash their teeth at Man’s supposed spoliation of that other grand abstraction, ‘The Planet’.

In our context, the issue is that the standard treatment concentrates on the cohorts moving from low-income, dissaving youth to high-saving middle age while seemingly failing to notice that this is also the highest spending segment of the community. In similarly fretting that some of this latter group are shuffling on into their bowed and income-pinched dotage, it forgets that this is where they increasingly liquidate savings, not augment them and so reduce capital means once more (that being largely their purpose, of course).

How the balance of that arithmetic is to play out is surely a much more complex issue than the crass construction we habitually get that Oldies save, the Young spend, and that, if the latter are not profligate enough to absorb the thriftiness of the former, the Keynesians and their central bank facilitators wish the politicians to act like spoilt children in their place.

True, the dreadful welfare state overhang of Ponzi-scheme social security systems will have to be dealt with, as thorny as its resolution may be. But even this does not require the stark choice of risking alienation in one’s own land and the heightening of racial, religious, and cultural stress through the blind encouragement of ‘Wir schaffen das’, mass immigration. The alternative – simple in exposition, if not so in execution – is to employ the majority of such people at home in their own countries by exporting one’s capital to them.

Of course, this requires that their political systems evolve beyond their often barbarous current condition so that property rights may be secured and investment made feasible (a development which will immediately enrich them – and even their now-sanitised, WEF-acceptable, former warlords and kleptocrats – in all manner of ways besides). It also demands an end to the knee-jerk of fear with which the offer of much foreign investment is habitually greeted.

‘They’ may well be ‘Over Here’, buying up ‘Our’ companies, but They are also putting tools in Our hands and money in Our bank accounts as They seek to provide for Their own future needs via the fulfilment of Our present ones.

Let us therefore speak of ‘demographic decline’ and of the lack of productive and remunerative outlets for capital when it embraces the whole of humanity and not before.

Even at that point – surely one unimaginably far off into the future and so well beyond our veil of predictive ignorance – let us proceed to a situation where more and more decrepit retirees do now live alongside fewer and fewer vigorous workers. This, we are told, is a bleak and insupportable scenario, but why?

The surviving old will still have to employ what young there are and the scarcer these latter become, the higher their real wages will be. As real wages rise – and as the need for material aids to fortify that diminishing pool of labour also increases – both the incentive and the necessity for the greater use of capital will also rise – and with it the real return to be earned upon it.

Incidentally, if their quality of lives rises, as it will if they command an ever greater per capita share of even a shrinking pool of aggregate resources, the remaining young might even start thinking about breeding more prolifically and so might they eventually arrest, if not reverse, the population decline long before extinction looms.

Taking it to a somewhat science-fiction absurdum, the Omega couple man and his wife, whose sole task it is to monitor the working of the vast battery of robotic day-care and medical apparatus which keeps the wrinkled mass of humanity alive and in some comfort, will enjoy an income almost beyond imagining, in direct proportion to the uniqueness and value of their role.

This mirror image Adam and Eve will therefore find the gates to Eden once more unlocked at their approach.

Exorcising the Bogeyman

We can sum up this rather lengthy exposition by borrowing Mr. Terborgh’s own conclusions, as written seven decades ago.

‘The system of private enterprise is either dynamic or it is a failure. It is the first task of economic statesmanship, therefore, to create under the altered, social, political, and economic conditions of today an environment hospitable to enterprise, sympathetic with its incentives and necessities, sanctioning its rewards. For this will prove in the end the only protection against the continued encroachment of public production and investment.’

‘Although the rejection for stagnationist theory does not solve this problem [of cyclical upsets], it is a necessary prerequisite for its solution. Sound therapy cannot rest on a mistaken diagnosis. If we conceive our task to be the dampening of cyclical fluctuations, we will do one thing: if, on the other hand, we fancy ourselves engaged in combatting a chronic debility brought on by economic maturity, we shall do another.’

‘In the long run, it can make a tremendous difference to the economy which diagnosis and course of treatment is espoused as the basis of national policy. For if our appraisal of stagnationist therapeutics is correct, the remedies proposed for economic maturity may well produce the stagnation they are supposed to obviate.’

Yes, indeed!