"I think we - as the authorities, central banks, regulators, those involved today - are the inheritors of a 50-year-long, large intellectual and policy mistake." ~ Lord Adair Turner
We finally found time to finish viewing the keynote presentation of Lord Adair Turner at the recent INET conference in Hong Kong. In our opinion, it is a must-see. Mr. Adair's speech validated a new policy frontier for central bank chicanery and sleight-of-hand. He called it Overt Permanent Money Finance or OPMF. Moreover, he laid out its theorems visible for all to see. While there have been veiled references and discussions on this topic in the past, this was out in the open ... all taboos to the wind. We would consider Mr. Adair's recent speech as the "coming out" of OPMF.
We'll here briefly explain why you should know about OPMF, what it is contemplated to achieve, and why it will possibly lead to a new boom-bust cycle like perhaps never before. First, we'll express it in "formal" language and then we'll tell you what it really means.
INET, for those who don't know, stands for Institute for New Economic Thinking. It was founded and funded in large part by George Soros in 2009. Its stated objective, according to the INET website, is to "accelerate the development of new economic thinking that can lead to solutions for the great challenges of the 21st century." While still relatively new, it is gaining much influence and is attracting high-profile economists such as Lord Adair Turner and others to its ranks.
George Soros, in an interview at the recent INET conference, expressed enthusiasm for OPMF. In fact, much more than that. He said something to the effect that, in his consideration, he believed Lord Adair Turner (advocate of OPMF) to be one of the most brilliant economists alive today. Whatever you think about Mr. Soros, an endorsement by such a man of vigor, intellect and unconscionably huge wealth, urges that you find out why Mr. Turner is considered so brilliant supposedly.
Just what is OPMF? It is this: To have central banks directly finance the budget deficits of governments. In other words, central banks would buy new issue bonds directly from a government's treasury in exchange for newly issued money. The central banks gets the bonds; the government gets the money in its bank account to spend. Disappointed? Well, hold on, this is considered genius (even if you don't think so). Here's the claimed reasoning:
Firstly, lack of demand is the easiest economic problem to fix according to today's macroeconomists. Since there is a lack of demand today (so it is reasoned), it is therefore elementary and imperative that something must be done about it. In fact, to not do so would be irresponsible. (Please note, these are "their" views, not necessarily that of us raconteurs.)
But, how to raise demand (to get people buying and selling more stuff) when the household (and entire private sector in some countries) is deleveraging and pressured to spend less? No problem. Policymakers must continue to move indebtedness over to the public sector. Get governments to take on the debts in one way or another. We can deal with government debt more easily than we can household mortgages and other private debt.
We know that elected governments will never have a shortage of spending needs. As an economist might put it, governments' proclivity to spend is bottomless. There is conceivably unlimited opportunity for spending whether "pork barrel," transfers to the private sector, new and improved bridges ... maybe even settlements on the moon. In short, you are sure to get a bang for the buck if you give governments free money. (We can hardly recall that we used to be told that governments were inefficient and wasted money!)
Once the demand boost is underway, economies can now grow faster ... corporate profits can soar to even higher shares of national income. Such stimulus can be created for as long as needed. And, not to worry, OPMF "speedball" injections directly to the spending aorta can be withdrawn at any time necessary. "Please believe us, we promise that we will withdraw."
But what about the copious government debt that will fund all this spending? That's where the "P" in OPMF comes in -- namely, the word "permanent." Actually, slipping this "P" into the acronym is somewhat disingenuous because what is really meant is that the debt will never ever be paid back by the government. Never.
All of the above is brilliant because, among reasons: 1. Giving government money directly in this way doesn't crowd out other private borrowing; 2. It provides direct spending stimulus to the economy (as opposed to trying to generate demand through indirect means ... after all the QE programs are increasingly losing traction); and 3. It circumvents the demand-retarding effects of deleveraging in the private sector.
The worst consequence that can be imagined by the OPMF advocates is that it might unleash some price inflation. But again, not to worry. This is well controllable by central banks, though we know that this has not been reliably demonstrated over the "past 50 years." Besides, aren't gold bullion markets signalling that inflation is not a problem?
In short, brilliant.
We see some deathly theoretical flaws with OPMF. In fact, we potentially see them to be "society killers." But before that happens, OPMF could trigger quite a ride in financial markets. It may already be unfolding.
Before we explain further, we'll stop right here for a moment and get something off our chest. We don't like OPMF. It does not agree with our moral sensibilities. Yes, we realize that the arenas of Political Economy and Geopolitics are best engaged with a cold cup of amorality (i.e. no hindrances from any do-right notions of morality.) After all, the ultimate aim of these two crafts is to serve the materialistic interests of sovereign nations and their constituents. We get that.
Nonetheless, we still don't endorse OPMF and for that matter, we will not apologize for markets nor the reckless policy prescriptions (past and present) of policymakers. We don't control them. Our job is to manage our clients' assets and therefore we must remain focused on "what is" rather than "what should be."
On that note, let's next focus further on a few "what is" factors:
If it is only the government that will get free money (in all of its senses) under OPMF, then we need to follow what they will be doing with the money. Upon what will this money be spent? To the extent that government spending ends up in the private business sector (i.e. buying goods and services or transferring money to households who then turn around and buy goods and services,) corporate profits will be boosted. This will be sure to get stock markets enthused.
If government debt is never contemplated to be paid back to the central bank, wouldn't it be more correct to say that the central bank gave a free gift of money to the Treasury Department? We would say yes. This opens the door to abuse ... and much more malinvestment and economic distortions.
Real wealth cannot be created out of thin air. What these new OPMF policies must therefore produce is large shifts in relative wealth between different economic agents and households. Wealth distribution skews will continue to widen ... the 1% amassing even more relative wealth. (Wealth distribution is already at its most imbalanced in at least 8 decades in the U.S. not to mention similar trends in other countries.) This is one of the structural problems to begin with.
While Mr. Adair and other erstwhile and mutually-congratulatory money alchemists will no doubt continue to reinforce the notion that their ideas are new and brilliant, they are in fact not. The underlying premise -- buried under mile-high sedimentary layers of academic-speak, theoretical obfuscation, references to dead economists and so on -- is a fascist wealth transfer. That's harsh language. Even harsher (and more accurate still), is the word theft. When massive amounts of wealth are being transferred by effect of the policies of an unelected central bank (not by way of labour or savings nor a properly empowered congress) what would you call it, dear reader?
We also have to consider the impact of OPMF upon currencies. All of the above theories of the "new thinking" magisterium, assumes that impacts upon currencies will be quite orderly because all major central banks will be nicely cooperating together. This is hardly sure and the potential impact upon individual country stock and bond markets of any dissonance will be sure to be quite marked. This will mean both opportunity and risk.
What also is not sure is the actual long-run impact of OPMF. Beyond an initial financial euphoria, the long-term impact could be directly opposite to what policymakers may believe. Besides a further concentration of wealth, we could make a case that a continuing low-interest environment will push the corporate sector even further into dividend-paying mode, cutting capital spending, even as the household sector suffers a much further contraction in real income. All of this could actually be deflationary. In short, there are plenty of reasons to expect that the "50 year policy mistakes" by ambitious central bankers could continue.
Were we pushed to the wall, we would say that the world of Overt Permanent Money Finance is already upon us. Clandestinely, thanks to the Bernanke Fed, it may already have been in force for two years or more. The U.S. Fed has already bought a lot of U.S. treasury bonds (at last count, $1.86 trillion worth). If you believe that these bonds will never be sold back to the public sector or paid back by the government, then you are asserting that OPMF is already underway. The stock market, by all appearances, seems to already know that.
If you've been puzzled by the inexplicable strength of stock markets in recent months, despite a clearly decelerating economic ebb and wilting earnings, then the growing expectation of OPMF could be your answer. Stock markets may already be "looking through" the current economic slowdown to the halcyon promises of the dawn of the age of OPMF.
Of course, we recognize that no future scenario will have a 100% probability. However, the one that we have outlined here just happens to be one of the current eight that have been part of our strategy set for a number of years. Its probability of occurrence is rising fast.
Looking ahead, having been given the stewardship of our client's assets, we must strive to stay ahead of the monetary machinations and competitive unorthodoxies of the major central banks. The "new economic thinking" being applied, therefore, also requires new portfolio strategies.
As such, many economic theories and financial market response have been entirely turned upon their head. Today's financial markets are far more theoretically treacherous and non-intuitive. The obvious may not be what it seems; and opportunity may lie right in the mouth of the lion. In a sense, the latter is the situation we see possibly playing out. OPMF, while at first appearing as a gift in the mouth, will turn out to be a hominus-eating carnivore.
As OPMF gains further influence in policy circles, we speculate that financial markets (both bonds and stocks ... the latter certainly so) will initially be (perhaps already is) in a celebratory mode. In fact, it may yet be a full-blown punch bowl party. Intoxicants such as free money and free government funding will do that. But only for a time. The flaws that we have cited will, in time, come to the fore.
In conclusion, we think it is a significantly high probability that OPMF will be implemented in time by all of the major central banks of the world (with the possible exception of a few ... the Bundesbank?). Why? Because the major economic hindrances that the western world is experiencing are not entirely the result of high indebtedness alone, but, also some serious structural issues (i.e. demographics, uneven wealth distribution as mentioned, massive malinvestment overhang ... etc.). The economic growth disappointments borne of such factors will prompt greater calls for OPMF. As such, along the way, we must expect sharp slumps in stock markets from time to time, creating the crisis environments that break the policy inertias that may stand in the way of OPMF. These will also likely be stock buying opportunities.
Should OPMF possibly play out as we theorize, it will be a market environment that few can afford to miss ... most crucially so for future retirees. Equity markets are likely to the greatest beneficiary. More than ever, macro tactical strategies are called for. We will be sure to keep our "new thinking" hats on tight; stay wary of erudite sophistries; and above all, keep our hands on our pockets.