Here's The Argument That Wins In 2016
Vox is a fairly new website with a mission to not just report the news but explain it. A typical article will lead with a lot of background, bringing readers up to speed on what the subject is and why it matters before moving on to current events. All things considered, this is a great site with a refreshing approach.
But it's not always right. The following article is a backgrounder and opinion piece on why easy money is a good thing, and why the US needs to emulate China and throw newly-created currency at stock market corrections and other intolerable problems. It's well-structured and well-written, and is exactly the kind of argument that will impress desperate politicians when the current volatility turns into full-fledged crisis. As such it will provide intellectual cover for next year's opening of the monetary floodgates:
There's a lot to criticize about how the Chinese government has handled the recent stock market turmoil. Over the past two months, Chinese regulators have banned some executives from selling shares, ordered other companies to buy shares, and provided government funds to finance debt-funded stock speculation. Those steps were only going to make things worse in the long run.
But this week, China's government did something that made sense: It loosened monetary policy. By flooding the economy with cash and lowering interest rates, China's central bank hopes to cushion the economic downtown and hasten a recovery.
Central bankers in the United States and Europe would be well advised to follow China's lead. They can't do exactly what China did because interest rates here and in Europe are already at zero. But the US Federal Reserve and the European Central Bank can and should be doing more to support economic recovery.
Printing money boosts economic growth
The basic job of a central bank like the Federal Reserve is simple. When the economy is weak, the bank boosts economic growth by expanding the money supply. The limit to this strategy is that printing too much money will create inflation. But in general you should try to boost the economy as much as possible without creating an inflation problem.
Right now, most economic data suggests that the Fed has been doing too little to support the economy. Over the past couple of years, the unemployment rate has fallen to 5.3 percent. That's pretty good, but it could be better. The unemployment rate stayed below that level for multiple years during each of the last two expansions. The economy has also been growing at only about 2 percent per year, below the rate of previous expansions.
THE FED IS DOING TOO LITTLE TO SUPPORT THE GROWTH OF THE AMERICAN ECONOMY
And there's no reason to worry about inflation getting too high. To the contrary, prices rose just 0.2 percent during over the last year, far below the Fed's 2 percent inflation target. That's mostly because energy prices have been dropping, but even if you exclude volatile food and energy prices, the inflation rate is still a too-low 1.8 percent.
Of course, just because inflation is low now doesn't mean it will be forever. But fortunately we can also measure market-based expectations of future inflation by comparing how the market values inflation-adjusted and non-inflation-adjusted bonds. According to this measure, markets expect the average inflation rate over the next decade to be below the Fed's 2 percent target:
All of these indicators suggest that the Fed is doing too little to support the growth of the American economy.
And things are even worse in Europe. While Germany and a few other countries are enjoying decent unemployment rates, the unemployment rates in Greece and Spain are reminiscent of America's Great Depression. And inflation in the eurozone is an anemic 0.2 percent, suggesting that the European Central Bank could do a lot more to support the economy without worrying about inflation.
Interest rates are zero, but that doesn't mean central bankers are powerless
Ordinarily, central banks conduct monetary policy by targeting interest rates. When they want to stimulate the economy, they announce that they're going to print more money until short-term interest rates fall to a new, lower level. China did that on Tuesday, cutting a key interest rate to 4.6 percent.
But since the 2008 financial crisis, short-term interest rates in the United States and the eurozone have been close to zero, leaving little room for further rate cuts. That has created a misconception that they can't do more to support economic recovery.
But cutting short-term interest rates is just one way for central banks to boost the economy. Fundamentally, central banks conduct monetary policy by creating new money and using it to buy assets. When a central bank "cuts interest rates," what they're really doing is printing money and buying short-term government bonds with it. That becomes ineffective once short-term interest rates fall to zero. But central banks can always buy other assets.
CUTTING SHORT-TERM INTEREST RATES IS JUST ONE WAY FOR CENTRAL BANKS TO BOOST THE ECONOMY
Indeed, that's exactly what the European Central Bank began doing earlier this year: It began buying long-term government bonds in a program called "quantitative easing." The Fed used the same strategy to pull the US economy out of recession from 2008 to 2014. By 2014, the Fed believed it had done enough to get the economy growing again, and it halted the program.
But the last year's economic data suggests that judgment was a mistake. The US economy is still weak, and more stimulus would be helpful. And while the ECB's bond-buying program was a step in the right direction, it's becoming clear that it should be doing more as well.
The fact that China devalued its currency earlier this month and cut interest rates this week provide an additional reason for easier money in the US. A weaker yuan means that Chinese goods are cheaper in world markets, making it harder for US exporters to compete. Looser monetary policy can boost domestic demand, cushioning the blow for US exporters.
The Fed's big problem is political rather than economic
The past year has seen slow economic growth and very low inflation, which would ordinarily be seen as signs that monetary policy was too tight. Yet in recent months, the Fed has been debating whether to make monetary policy still tighter, by raising interest rates for the first time in six years.
The reason for this is that despite economic data suggesting monetary policy is too tight, many people believe Fed policy is too loose. Before 2008, it had been decades before interest rates had fallen to zero. And so people believe that six years of zero-percent interest rates must be a sign that monetary policy has been dangerously loose.
But the Fed's hawkish critics are mistaken. Six years of zero-percent interest rates are not necessarily a sign that monetary policy has been too loose. Indeed, if we want to eventually return to a "normal" economic environment of non-zero short-term interest rates, the last thing the Fed should do is raise interest rates now.
Just as 10 percent interest rates in the 1970s wasn't necessarily a sign of tight money, today's historically low zero-percent interest rates aren't necessarily a sign of loose money. If money were really loose, we'd see a booming economy and rising inflation. Instead, growth and inflation have both been low for the last seven years.
The real (and, alas, obvious) flaw in the inflationist worldview is that the only true way to avoid the tumult that follows asset bubbles is not to blow bubbles in the first place. A "throw money at every problem" strategy, in contrast, only guarantees more and bigger asset bubbles by encouraging excessive borrowing. Their short-term success plants the seeds of future disaster.
The article also fails to note that we've been following such a policy since at least the late 1990s when Federal Reserve chair Alan Greenspan responded to a series of crises in Asia and Latin America (and here, with the collapse of hyper-leveraged hedge fund Long Term Capital Management) with lower interest rates and accelerated currency creation. Easy money, in other words.
That this worked in the moment gave credence to the idea that it was good policy. That it resulted in a ratcheting up of systemic debt that made each successive bust bigger than the one before was conveniently overlooked. Easy money advocates seem to take the world as they find it, with the amount of debt weighing on the system accepted as a given. Instead they should be looking at how we got here and learning the long-run rather than just the short-run lessons of past policy choices. Why, for instance, are interest rates already at zero? Could it be that all the debt we took on to battle previous crises makes growth under normal interest rates impossible?
Anyhow, Vox's argument is about to win. It will be echoed in the New York Times by Paul Krugman and others, on Wall Street by the big banks that control the government (and that literally own the Fed), and by legislators who have elections coming up (which is to say all of them). By early 2016 it will be mainstream conventional wisdom, and the resulting easy money policy will dwarf the QEs that came before.
In so many ways this is shaping up as 2008 redux, only bigger and much, much more chaotic.