By Reuven Brenner
(Part I of this series appeared on April 12)
Instead of relying on his predecessor’s experience, and calling his policy by name as being fiscal in nature, sustaining government credit (though politically this is not so palatable during peacetime), Mr. Bernanke appears to have his mind trapped by academic abstractions. He says: “As Larry’s (Summers) uncle, Paul Samuelson (the person who popularized macro-economics in his textbook in the U.S.), taught me in graduate school at MIT, if the real interest rates were expected to be negative indefinitely, almost any investment is profitable.” I have no idea if Mr. Samuelson actually said the meaningless “indefinitely,” but would not surprise me. After all, he is the author of Fundamentals of Economic Analysis, which – astrology books-like – is filled with simple linear algebra and trivial differential calculus, but no mention of risk, uncertainty, entrepreneurship, money, contracts – nothing to shed light on a business society, or human nature.
No wonder that until in the 11th edition of his popular textbook, which spread the teaching of “macroeconomics” around the globe too, he taught students that it was a “vulgar mistake to think that most people in Eastern Europe are miserable.” The major revision in the 11th edition was that he eliminated the term “vulgar.” The 12th edition, in 1985, omitted finally the sentence, and replaced it with the question whether the economic gains achieved under communism were worth the political repression (a euphemism for tens of millions killed and starved to death, of which no mention is made in the textbook). What could Mr. Samuelson understand about prosperity being consequence of continuously matching people and capital more accountably? Nevertheless, the Nobel committee awarded him the economics prize too. This is how pseudo-sciences get established.
Mr. Samuelson is not the only dead economist who apparently influenced Mr. Bernanke’s thinking. He quotes another one too, Knut Wicksell, a late 19th-early 20th century Swedish economist. Bernanke writes that to explain the present low interest rates “it helps to introduce the concept of the equilibrium real interest rate (sometimes called the Wicksellian interest rate). The equilibrium interest rate is the real interest rate consistent with full employment of labor and capital resources, perhaps after some period of adjustment. Many factors affect the equilibrium rate, which can and does change over time. In a rapidly growing, dynamic economy, we would expect the equilibrium interest rate to be high, all else equal, reflecting the high prospective return on capital investments. In a slowly growing or recessionary economy, the equilibrium real rate is likely to be low, since investment opportunities are limited and relatively unprofitable. Government spending and taxation policies also affect the equilibrium real rate: Large deficits will tend to increase the equilibrium real rate (again, all else equal), because government borrowing diverts savings away from private investment.”
What “equilibrium”? What does Wicksell have to do with anything going on these days? What does it mean “all equal”? These days’ “disequilibrium” is comparable to the post WWII years – in the sense that the U.S. and West compounded a lot of mistakes by centralizing, and the rest of the world is in not particularly good shape to justify more borrowing. The result is high debt level, with the Fed and the ECB playing an explicit fiscal role (the latter because EU members’ debts are not mutualized), sustaining and even help increase government spending, facilitate continuous mismatching, and help prevent defaults. The “disequilibrium” is comparable too to the 1940 decade, in that young, ambitious, skilled people are trying desperately to get to politically more accountable shores – but are not let in.
One solution for today’s mismatch between aging populations in politically more accountable countries and skilled youth in politically less accountable ones would be to select youth to come in, bring about better matches with capital, and bring expectations of higher returns. The alternative of letting capital be matched in the less accountable countries, where such youth would stay put – is not in the cards. With thus capital flowing to the “aging, more accountable governments,” where the youth are preventing entry, is recipe for both lower returns and increased political instability in places with frustrated youth. Young people climb barricades – old people don’t. There is not much any central bank can do about this. But the present state has nothing to do with “equilibrium.” The disequilibrium is there for all to see in the 4,422,660 visa applications as of November 2014, with a quota of 370,000 for 2015. By April 7 this year, the yearly quota for HB 1 immigration status, letting qualified immigrants into the US, which start April 1 was already filled. In the Mediterranean, hundreds of thousands of “boat people” have been floating toward Europe. None of the above has anything to do with “cycles,” or “secular stagnations.”
Briefly, the situation during the 1940s and the last decade are comparable. Wars, like grave miscalculations in demands and valuing housing as assets (rather than “consumption”), have led to large accumulation of debt. Once these debts exist, the interest must be paid to prevent defaults. The government is the single biggest debtor and present and future taxpayers are the biggest creditors. In times of distress brought about by wars or gravely mismatched resources (as in housing, among others), “the state” carries the burden, one way or another. The question how will society pay for the debt does not have a unique answer: It can prevent default through inflation and devaluation; pay for it in taxes; Or, in the present case, pay for it by central banks engineering low or even negative interest rates – as the Fed itself has done during the 1940s, which is fiscal, arbitrary redistributive policy done with monetary tools. The low interest rates help both sustain government spending, and the competition for lowering the rates among countries, brings about devaluation, subsidizing exports – without changing domestic regulations, taxes and laws. The facts are that this fiscal policy in disguise, carried out with monetary techniques, allowed for total debt payments in 2014 to be the same as in 2007, $430 billion, though total U.S. federal debt rose from $10 to $18 trillion during those years.
But it should be clear that the Fed-engineered low interest might not have been achieved if the situation in the world now was not comparable too to that of the 1940s. The U.S. now is in a better position than the rest of the world, just as it was then, with capital and brains flowing toward it. Europe was devastated then, and it is not in very good health now either, and the rest of the world was pretty much an uncertain question mark then, as it is today. Though China is rising, it is still a one party country, controlling the country’s banks, and thus much of the “matchmaking” between talents and capital. Thus there are still few places where capital and talents can be hoped to be matched more accountable manner.
We started with “macro-economics” and we now finish with it. This pseudo-science is based on a language that Keynes invented in the 1930s, and which his followers (to whom Keynes referred to as “fools”), developed to esoteric depth. Keynes and his followers claimed that government bureaucracies and politicians, collaborating with central bankers and with total disregard of other institutions in a country, could create eternal prosperity by solving a few equations with a few unknowns. The models also assumed that whereas entrepreneurs, businessmen and the “hoi-polloi” suffer random bouts of pessimism and optimism – subject to atavist “animal spirits” – politicians, bureaucracies and economists at central banks – now hold your breath – are immune t such primitive emotions and can counteract them promptly. Governments, central bankers and dictatorial rulers in all ranges of the spectrum were happy to use and heavily subsidize spreading the macro language and analyses, putting their practitioners in the limelight, as it rationalized increasing their powers.
That’s how pseudo-sciences are born and spread. “Stupidity is not ignorance, but the non-thought of received ideas,” Milan Kundera once wrote, a statement perfectly illustrated in macro-economists’ writings. What can end being trapped by dogma, by living with the musings of other people’s thinking? A variation on the observation that “Necessity is the Mother of Invention”: I do not know what “necessity means,” but the evidence is that for business and countries, “Facing Default is the Mother of Invention, but It Can Be the Step-Mother of Deception too,” if the wrong person happens to make decisions at the defaulting time. As we may be getting closer to such times, so let’s hope that people will re-invent more accountable political institutions, and get rid of the macro-strology that blinded government and central banks’ decisions for the last few decades.
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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