By Reuven Brenner
During the last few weeks, Larry Summers came up repeatedly with speculations that what’s happening today is “secular stagnation,” meaning a lasting diminished “aggregate” demand in the world, in the US in particular. In contrast, Mr. Bernanke brings up cycles and special factors but not the Fed – to explain the low interest rates, whereas Krugman criticizes Bernanke, bringing up Japan as his counter-example.
Though their arguments are different, they are all wrong both in their analyses of the current situation and the solutions they propose. They rely on the vocabulary and models of what is called these days “macro-economics,” a field of study that looks at the world in terms of aggregates, but which is best compared to “astrology.” The solutions they propose may make sense within the macro-strological framework, but not in the world live in.
Most people are unaware of the fact that rulers perceived astrology for almost a century as “science” – pretty much as some perceive “macro-economics” these days. Monarchs, such as Charles I, as well as the learned and the nobility relied on Councils of Astrological Advisers. Books, presenting complex geometrical calculations linked to positions of stars, legitimized analyses and forecasts.
In England, from the time of Elisabeth to that of William and Mary, the status of judicial astrology was well established, and in every town and village, astrologers, like oracles in earlier times, just as “macro-economists” these days, had their “cyclical” models, and cast dates for prosperous journeys, for the marching of the army and for setting up enterprises. Abruptly, after a century, in part due to Galileo’s telescope destroying the science of political lies and hierarchies built on them, the astrological edifice disappeared in a puff – or so it appeared.
Except that macro-economics is now its modern incarnation: Only instead of stars, macro-economists look at “aggregates” gathered religiously by governments’ statistical agencies – never mind if the country has a dictatorial regime, be it left, right or anything in between, or has large black markets, as Italy and Greece do, where tax evasion has long been the main national sport. So let us first forget about this “macro” stuff, whose beginnings are almost a century old, and offer a simple alternative for shedding light on the situation today and on possible solutions, hopefully demolish this modern pseudo-“science” once and for all.
It is not difficult to shed light on what has been going for decades, since the 2008 crisis in particular, once one does not use macro-strology’s vocabulary. “Growth” happens when “matchmakers” combine talent and capital in a more accountable manner – “more accountability” meaning that there are more institutional arrangements that correct mistakes faster. When more matchmaking mistakes are done, and accountability in private and public institutions is weakened, we get “bad times.” When better matches are made, and mismatches are corrected faster, we get “good times.” As ideologues, politicians, bureaucrats, academics, regulators – all people without actual experience on how businesses survive matching talents and capital – become more often the “matchmakers,” mistakes compound and last longer. Combine such expansions of centralized decision making with weakened accountability of governments and of central banks in Western countries – we’ll come to the rest of the world below – and the “secular stagnation,” diminished innovations, and diminished demands for borrowing, that the three macro-strologists appear to be puzzled about, are not surprising.
With significantly diminished hopes of restored accountability and thus expectations of mismatches not being corrected anytime soon – you do not need any “macro-economic” models to shed light on low or even negative rates, and diminished productivity. Focusing on “real interest rates” in such a world is silly: What were real interest rates in communist Russia? Did such rates have much meaning to start with? What is the meaning of any price in centralized societies, where bureaucrats do the “matchmaking” between capital and talents?
Add to the compounding mistakes and weakened accountability in Western countries the fact that, with few exceptions, much of the rest of the world – Latin America, Russia, much of the Middle East, of Africa, of large chunks of Asia (China and now India being a bit of an exception) – has been doing their own moves toward more centralizing decisions, diminishing accountability and compounding mistakes – and the present global picture, low interest rates included, becomes comprehensible. Although the US has been doing its shares of grave mistakes, in the world of the blind, the one-eyed is king, which explains why capital, human and financial continue to flowing to the US in search of better and more accountable matches.
These facts and events have nothing to do with “cycles,” or “secular declines,” or just managing one particular price – interest rates, but models of society with diminished accountability. Compounding mistakes, and expectations of them not being corrected, or being corrected at a far slower pace than in the past, prevent a population of 7 billion – up from about 1 billion just a century ago – to find arrangements to match talents and capital in a more accountable manner around the globe. These mistaken policies are, in part, consequence of seeing the world through the disastrous “macro-economic” jargon and models – rather than through the prism of matching flows of capital, human and financial in a more accountable manner, preventing mismatches to last too long.
Before saying more about interest rates, the Fed and demography, let’s start with Mr. Krugman, because his views are the easiest to discard. When he criticizes Mr. Bernanke’s views, he brings up Japan’s lost decades as an example of governments and central banks not having responded properly to the “inadequate demand” during that country’s so-called “lost decades.” His remedy at the time? Central banks should have made interest rates negative enough. How negative? And how to do that? In debates with Richard Koo, previously at the NY Fed, then chief economist at Nomura, Mr. Krugman said that “Japan needs a 200 percent or 300 percent inflation rate … and the central bank declare its intention of acting irresponsibly” (italics in the original Koo book, titled the Holy Grail of Macroeconomics). People get Nobels these days for such macro-strological insights.
Yet Japan’s problem at the time, besides grave fiscal mistakes (the drastic increase in the effective capital gains taxes on housing being prominent), were already compounding for decades by sustaining the so-called “zombie companies,” banks included, propped up by a range of government regulation, domestic cartel arrangements, and easy government-induced credit, among others. Perceiving problems through aggregates, don’t offer solutions to this problem.
Not that Bernanke or Summers offer any better insights or solutions. Few days ago, in his first Brookings Institute posting, Bernanke asks “Why Are Interest Rates so Low?” His answer is that the Fed has nothing to do with this: “The Fed’s ability to affect real interest rates of return, especially longer-term real rates is transitory and limited. Except in the short-run, real interest rates are determined by a large range of economic factors, including prospects for economic growth – not by Fed.”
Bernanke apparently forgot his 2002 speech where instead of abstract theorizing, he documented just the opposite, namely that Fed was successful in keeping real interest rates low – for a decade:
“Historical experience tends to support the proposition that a sufficiently determined Fed can peg or cap Treasury bond prices and yields at other than the shortest maturities. The most striking episode of bond-price pegging occurred during the years before the Federal Reserve-Treasury Accord of 1951. Prior to that agreement, which freed the Fed from its responsibility to fix yields on government debt, the Fed maintained a ceiling of 2-1/2 percent on long-term Treasury bonds for nearly a decade … The Fed was able to achieve these low rates despite a level of outstanding government debt (relative to GDP) significantly greater than we have today … At times, in order to enforce these low rates, the Fed had actually to purchase the bulk of outstanding 90-day bills.” (italics added).
Indeed, in a centralized economy, with limited trade with the rest of the world – as the US was during and after WWII, the Fed could – and did – keep real interest rates low, and in negative territory (though what was “real” when most prices were administered, as was the case in the decade of the 1940s, is a good question). But Mr. Bernanke is wrong not only because he forgot his own speech, but also because he fails to mention now that the Fed was carrying out then a fiscal policy under the Treasury’s direct instructions, perceived necessary for financing the war.
The Fed Chairman at the time, Mr. Marriner Eccles, was explicit – as Mr. Bernanke is not – when he wrote in 1951 that the Fed’s purpose was preventing default – quote – “maintenance of government credit.” Mr. Eccles made this explicit when he wrote that: “For the first five years (war years) of the last ten years, the problem was mainly fiscal, rather than monetary. Had we financed the war in greater part from tax receipts both our war and post-war problem would have been substantially reduced. But once the decision was made by the government to finance the war in large part by deficit financing, the Central Bank could not deny … the Government money with which to wage a war for survival … With respect to freezing of rates it must be remembered that you cannot engage in large scale deficit financing with a fluctuating interest rate pattern.”
Indeed, the Federal Reserve, or any central bank, can – under certain circumstances engineer low real interest rates, even negative ones and they have done so. The Federal Reserve acted as a branch of the Treasury, carrying out fiscal policy with monetary tools and prevented default. The debating high priests today note that “macroeconomic theory” has no place for negative real rates, but then they fail to mention that the “theory” has no place for wars; for probabilities that governments could default; or for the fact that prices have little meaning when they are administered, be it under communism, or during the 1940s in the US, when The Office of Price Administration set prices, it being gradually dismantled starting only in 1947.
Mr. Eccles’ views find parallels in today’s world, that Mr. Bernanke misses. The accumulation of US and Western countries debts these days have less to do with wars and more with increasing government spending and commitments in the name of Great Society – Western governments having become the major “matchmakers,” directly or indirectly in housing, education, health, agriculture, various infrastructure, to name just a few. The increased spending created “incomes” and “credentials” (pieces of paper documenting years spent on “educational real estates”, though not backed by increased skills, getting more “zombies” rather than more “zombie companies”) – but no “assets,” tangible or not. The resulting accumulation of debts could have been prevented if governments were held more accountable for their “matchmaking” – and it may have been easier done with peace-time spending than during wars, that Mr. Eccles suggested was possible during WWII. It was not done then, and was not done during the last decades as the West marched herd-like pursuing the Great Society “government investment” myth.
Part II of Brenner’s piece will be published tomorrow by Asia Times.
Reuven Brenner holds the Repap Chair at McGill University’ Desautels Faculty of Management. The article draws on his books, Force of Finance and World of Chance.
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