Pushing On A String II

In this New World, the entire pool of theory on interest rates is trashed immediately. Actually if we think about it, when the concept of interest rate was conceived, it was in lieu of a surplus generated by labour of a person, immediate consumption of which was postponed. Owing to self-consumption, the surplus generated by any individual was limited. This level of surplus of various individuals set the interest rate. However today, thanks to central banks and fiat money (and Gold Standard also long gone), the supply of money is unlimited, and with all the financiers, anybody who is not in the NINJA (No Income, No Job/Asset) category can have access to credit and consume immediately. So intuitively, with unlimited supply of money, the cost of money should be zero in the current age.

With the pace at which technology is advancing and replacing labour, and the labour pool already oversupplied, the value of labour should also diminish significantly, or alternately lead to rising unemployment of unskilled labour. That leaves us with the final factor of production, i.e. Land. This is an asset which is now the fancy of citizens and bankers alike and the value of which keeps going up as the buyers queue is longer than those of the sellers. And to add fuel to fire, land is used as collateral to make more loans. More money becomes available which leads to further increase in the price. More loans are available against the increased value of land, which in turn again raises the value of the land, thus becoming a self-fulfilling prophecy. The culprit here again is money (investors pushing up prices) and not genuine demand (consumers who actually need to use the land).

Wayout (or bailout)

In this new world, the policymakers know that with an existing high GDP base, dwindling population, shrinking working age population and limited real productivity gains, its hard to repay the debt it has taken on the balance sheet. The traditional way out of this ‘debt-trap’ is by debasing the value of money i.e. inflation. But in this new scenario, we have money of different colours, i.e. different currencies. And so the major currencies of this new world have the privilege of having insatiable demand despite them offering nothing in compensation. And therefore until such a demand exists, central banks printing these currencies can keep expanding their balance sheets free of cost and without any inflation either, which in turn is a very sensitive issue politically. And the masterstroke is to keep the interest rates at zero so that even when the money is recalled by the lenders (not insignificantly foreign), they can simply print the same amount (not a penny more) and give it back, however late this recall may be in the future.

There is also seemingly a bit of a doublespeak here. China seems to have done/been doing a similar thing. They have been trying to invest and grow without demand keeping pace. This has lead to development of stressed assets in their banking system and touted to be a bad thing. I wonder why since some banks are government owned, and the others which are not can be bailed-out by the government, just in the same manner as America bailed-out their entire financial system, which was far bigger than the Chinese bad loans. And at least China has some physical infrastructure to show for it, while I wonder what has America to show as assets (except paper) against all the liabilities that the government has taken up on its balance sheet. Perhaps the obsession with GDP and the flawed definition of GDP which does not account for a debt write-off or a bad debt write-off (in the parlance of a company) that has created misplaced incentives, leading to all sorts of larger and more real problems without commensurate benefits, at least not for the majority of the people.

Another way out of this trap could be extending the coupon, maturity or terms of the sovereign bonds. To quote Bloomberg View columnist Mark Gilbert, “As a January 2015 paper by Harvard finance professor Carmen Reinhart and IMF economist Maria Belen Sbrancia explains, U.S. bondholders found themselves press-ganged into holding securities that took longer to get repaid and for which there was no secondary market. Marketable bonds were exchanged for non-marketable bonds (bonds that the holder could not sell) at a much lower coupon and longer time to maturity. It wasn't quite a default; but I bet it felt pretty uncomfortable for the investors who found themselves held hostage.”

A growth-obsessed albeit demand-starved world is leading to artificial GDP growth and as a consequence, an ever-larger share being contributed by finance-related activities which alone are capable of ‘creating’ growth. In such a scenario, the effectiveness of monetary policy is like ‘pushing on a string’ in the words of JM Keynes. And interest rates are of less significance anyway in a service-dominated economy. Perhaps some protectionist measures on labour or goods and services or both could begin a spiral of trade barriers/wars. Whichever way we look at it, the successive governments have the task of finely balancing productive employability of their voters while not annoying their trade-partners.

The peculiarity is that both the voters and trade partners also happen to be lenders. So perhaps they might as well pay heed to former Fed chairman Paul Volcker’s response to the question on his favorite financial innovation of the past 25 years. Answer: The ATM. “It really helps people, it’s useful.” Coming from someone of Volcker's stature, it is implicit that all other innovation in the financial world doesn't add much value and has increasingly becoming a Ponzi scheme to transfer income/wealth from the have-nots to the already rich. I don't want to sound like a leftist and I am not one. I am merely trying to elucidate the perils and possible consequences of capitalism in its current state and form.

This is the final piece of a two-part series. You can read the first part here