An amusing piece from John Hempton at Bronte Capital that tries to get to the heart of the mess:
The Federal Reserve has too much credibility. Each time it increases the money supply it buys some asset (say a government bond or even a foreign security) and issues cash. And people hold the cash because it is a reasonable store of value. And it is a reasonable store of value because they trust – at the end of this cycle – that the Federal Reserve will eventually take its vault full of assets, sell the assets for hard cash (which it will destroy) and will thus suck the excess liquidity out of the system.
If people really believed the cash was trash they would all try to get rid of it (i.e. buy something) but collectively they could not get rid of it (every time they buy something it would have a new owner) and the result would be inflation. Inflation would then reduce the real value of the money stock to a level where people were comfortable holding it.
To get inflation you need to damage the Federal Reserve’s credibility. You need the Federal Reserve to make a credible promise to be reckless.
And Ben Bernanke – despite the helicopter speech in which he outlined this view of the world very clearly – is not your man. Maybe it is the facial hair – but he looks – well, just too responsible.
[Bernanke] should not only announce that the Fed is buying Italian debt. He should do it whilst wearing an Hawaiian shirt and carrying a marijuana pipe. (I would even buy him the pipe…)
I agree with Hempton, but for all the wrong reasons. Firstly, the Fed has way too much credibility, because of the popular (but utterly wrong) idea that the Fed is capable of successfully managing the economy (and ending recessions) through monetary policy.
The problem is that most of the problems inherent in America and the West are non-monetary, and that at best, all that monetary policy can do is kick the can, in the hope of giving society and governments more time to address the systemic problems. The Krugmanite solutions that Hempton advocates — i.e. 6 or 7 years of 6% inflation and 2% interest rates, won’t solve the underlying systemic problems because they choose to ignore the systemic problems by instead focusing on money. I call it money-centrism.
As I wrote back in August:
These troubles are non-monetary: military overspending, political corruption, public indebtedness, withering infrastructure, oil dependence, deindustrialisation, the withered remains of multiple bubbles, bailout culture, systemic fragility, and so forth.
Since I wrote that I have moved toward the idea that the major problem at the core is systemic fragility. Simply, the high levels of interconnected leverage mean that one default (like Lehman brothers or AIG) can trigger many, many others, causing the system to collapse. The solution to this has been that monetary policy has taken on another task: the abolition of (large-scale) default. This has been done through two mechanisms, one local and one systemic.
At the local level, whenever a crisis hits and a “systemically important” institution comes under pressure, it is bailed out. A the systemic level, there has been the abolition of deflation.
These mechanisms have made can-kicking the rule, rather than the exception. The trouble is that can-kicking means that a major depressive influence on economic growth (excessive inter-connected debt and leverage) is not cleansed from the system, as it would be by a full crash and collapse. This is the process that Japan has experienced for the past twenty years. I call it zombification — failed banks, and failed systems live on as zombies on state (monetary and fiscal) life support. The problem is that this sucks productive capital (via taxation and money printing) away from productive endeavours, and toward sustaining a failed and failing mess.
Simply, I believe that the financial zombies have to be liquidated. If that means the system fails, and most of the debt is defaulted upon, well then that is great. That means that productive capital — instead of going toward paying down debt — can go toward new productivity, new investment and new innovations — things that will help ease the other problems, like America’s oil dependency (alternative energy), withering infrastructure, and deindustrialisation.
So as the system zombifies, Bernanke’s credibility will eventually be eroded by the reality that we are not having a recovery. That is because the debate is entirely focused on monetary factors, and not focused at all on the real-world factors — industry, technology, productivity, energy, food security that are the real economy — and which are the factors which need to be addressed to achieve long-term economic prosperity.
Hopefully the debate will eventually move away from money and monetary policy, and toward the real world economy. I see a lot of green shoots from both ends of the political spectrum in that regard: the Occupy movement is finally talking about joblessness, and the Tea Party have long talked about American deindustrialisation and dependence on Arab oil and Chinese industry.
The truth is, Bernanke might as well have been wearing Hawaiian shirts every day for the last five years, and rolling and smoking some fat joints. His economic policy has saved the failed system that has caused and perpetuated many of the problems. Perhaps he thought he was buying time for the political establishment to deal with the “bigger-picture” problems. If he did, then he seriously over-estimated their abilities.