Rate cuts are on the table says the media one day.
Rate cuts are off the table, they say the next.
Then we hear from our own central bank.
Negative rates are ‘unlikely’, says Reserve Bank of Australia top brass Philip Lowe.
Nonetheless, Lowe has said that all options are on the table when it comes to stimulating the Aussie economy.1
The RBA says they have an effective set of tools to help guide Australia through turbulent economic times.
The problem with that school of thought, is that central bankers have the misguided belief that they can manage the economy, rather than allow the free markets to work.
Central banks and governments are obsessed with measuring growth gross domestic product.
A rather blunt tool, which simply captures the total value of money spent and received. And much of our $1.7 trillion economy relies on ever-increasing amounts of credit to achieve GDP growth.
Further to that — much like US central bankers — our own RBA has a dismal track record of predicting growth.
The thing is, we could all let these calls slide.
But the boffins refuse to accept that perhaps certain things are beyond their control.
Major economies around the world are seeing their economic growth splutter.
As a result, once dismissed economic school of thought is being looked at as a way to get growth back on track.
Central banks and governments are desperate to end natural boom and bust cycle.
As Jim points out today, modern monetary theory (MMT) and helicopter money are becoming popular ideas in the US.
For now they are being dismissed here as dangerous, but just how long will it be before we start copying central bank decisions from the US?
Read on for more.
Until next time,
The ‘Last Hurrah’ for Central Bankers
We’ve all seen zombie movies where the good guys shoot the zombies, but the zombies just keep coming because…they’re zombies!
Market observers can’t be blamed for feeling the same way about former Fed Chair Ben Bernanke.
Bernanke was Fed chair during 2006–14, before handing over the gavel to Janet Yellen.
After his term, Bernanke did not return to academia (he had been a professor at Princeton), but became affiliated with the centre-left Brookings Institution in Washington, DC.
Bernanke is proof that Washington has a strange pull on people.
They come from all over, but most of them never leave.
It gets more like Imperial Rome every day.
But just when we thought that Bernanke might be buried in the DC swamp, never to be heard from again…like a zombie, he’s baaack!
They keep getting it wrong…
Bernanke gave a high-profile address to the American Economic Association at a meeting in San Diego on 4 January.
In his address, Bernanke said the Fed has plenty of tools to fight a new recession.
He included quantitative easing (QE), negative interest rates, and forward guidance among the tools in the toolkit.
He estimates that combined, they’re equal to three percentage points of additional rate cuts.
But that’s nonsense.
Here’s the actual record…
That QE2 and QE3 did not stimulate the economy at all; this has been the weakest economic expansion in US history. All QE did was create asset bubbles in stocks, bonds, and real estate that are yet to deflate (if we’re lucky) or crash (if we’re not).
Meanwhile, negative interest rates do not encourage people to spend as Bernanke expects. Instead, people save more to make up for what the bank is confiscating as ‘negative’ interest.
That hurts growth and pushes the Fed even further away from its inflation target.
What about ‘forward guidance’?
Forward guidance lacks credibility because the Fed’s forecast record is abysmal.
I’ve counted at least 13 times when the Fed has flip-flopped on policy because they couldn’t get the forecast right.
So every single one of Bernanke’s claims are dubious.
There’s just no realistic basis to argue that these combined policies are equal to three percentage points of additional rate cuts.
And the record is clear: The Fed needs interest rates to be between 4% and 5% to fight recession.
That’s how much ‘dry powder’ the Fed needs going into a recession.
Dangerous economic thought bubble gains traction
In September 2007, the federal funds rate was at 4.75%, toward the high end of the range.
That gave the Fed plenty of room to cut, which it certainly did.
Between 2008 and 2015, rates were essentially at zero.
The current fed funds target rate is between 1.50% and 1.75%.
I’m not forecasting a US recession this year, but if we do have one, the Fed doesn’t have anywhere near the room to cut as it did to fight the Great Recession.
I’m not the only one to make that point. Here’s what former Treasury Secretary, Larry Summers, said:
‘[Bernanke] argued that monetary policy will be able to do it the next time. I think that’s pretty unlikely given that in recessions we usually cut interest rates by five percentage points and interest rates today are below 2%… I just don’t believe QE and that stuff is worth anything like another three percentage points.’
Summers goes on to call Bernanke‘s speech ‘a kind of last hurrah for the central bankers’.
But if monetary policy isn’t the answer, what does Summers think the answer is?
The government is going to have to spend money directly into the economy instead of relying upon some trickle-down ‘wealth effect’ to stimulate the economy.
Here’s what Summers said:
‘We’re going to have to rely on putting money in people’s pockets, on direct government spending.’
Remember the term ‘helicopter money’?
Milton Friedman coined the term 50 years ago when he made the analogy of dropping money from a helicopter to illustrate the effects of aggressive fiscal policy.
That’s essentially what Summers is advocating.
It might sound a lot like the idea behind Modern Monetary Theory, or MMT, but it’s not necessarily the same thing. MMT takes helicopter money to a whole new level, and Summers has actually been highly critical of MMT.
But the idea of direct government spending to stimulate the economy is the same, and it’s gaining traction in official circles.
There’s good reason to believe it’s coming to a theatre near you. And maybe sooner than you think.
All the best,