Greenspan's Shadow

Andi Xie has published an interesting article at Caixin Online entitled “Money Cannot Buy Growth”.  He makes a number of arguments we have also made here in the past. A few excerpts:

“In the four years after the global financial crisis that began in the summer of 2008, the United States' monetary base more than tripled and China's M2 has doubled. This is the greatest experiment in monetary stimulus in modern economic history.
Staving off crisis and reviving growth still dominate today's conversation. The prima facie evidence is that the experiment has failed. The dominant voice in policy discussions is advocating more of the same. When a medicine isn't working, it could be the wrong one or the dosage isn't sufficient. The world is trying the latter. But, if the medicine is really wrong, more and more of the same will kill the patient one day.”

 

(emphasis added)

We would add to that: even if the 'prima facie evidence' were to show otherwise, this would still not constitute proof that the 'medicine is working'. After all, whether money printing and the concomitant artificial lowering of interest rates 'work' in the sense of improving economic statistics is largely a function of the state of the economy's pool of real funding. This is why it  appeared to policymakers and most observers in 2004-2007 that the massive monetary pumping initiated by the Greenspan Fed after the collapse of the Nasdaq bubble had 'worked'.

 

Austrian economists never subscribed to this interpretation. They insisted that relative prices had been distorted by the Fed's policies and that an unsustainable boom had thus been set into motion that would eventually end with a major bust. They were right. The housing bubble and its aftermath have demonstrated conclusively that it is not enough to rely on the superficial empirical evidence provided by economic data – one must look beyond it.

This is one reason why Paul Krugman is in error when he e.g. argues that today's low interest rates on treasury bonds are akin to the market demanding that the government's debt burden should be increased even further. He is even more wrong when he argues that there has been 'no inflation' on account of the Fed's policies. 10% or higher annualized growth of broad money TMS-2 in every month without interruption since November of 2008 constitutes plenty of inflation. The fact that its effects haven't yet shown up in consumer price indexes is not tantamount to it being harmless.

Xie further:

 

“Structural reforms are difficult because they would upset a lot of people and are slow in producing results. Smart and powerful people usually want to produce quick results to show their worth. This is why policy actions often take the path of least resistance, even if they lead the world to the edge of the cliff.

The effectiveness of monetary policy was last discredited in the 1970s. The persistent attempts to revive growth with easy money led to stagflation. The lesson had a powerful impact at the time. Many theories were developed to explain why monetary policy didn't work. The rational expectation theory was the main one. Soon after inflation was killed by high interest rate policy and the resulting recession, many theories were developed to revive the argument in favor of monetary policy. Smart people want to be relevant and effective. This is why they cannot hold onto a theory that denies their relevance in the real world. This is why the economics profession so quickly embraced monetary stimulus again soA soon after it failed so miserably.”

 

(emphasis added)

Indeed, it is a great tragedy that most economists and policymakers don't realize that the economy actually doesn't need them and their plans. In spite of the countless failures of top-down economic planning, they still think it is superior to market-produced outcomes. It is not and never will be.

Xie also has a few words on Alan Greenspan and his bubbles:


In parallel with the new fondness for monetary stimulus, the economics profession in the 1980s advanced the theory of an efficient market with respect to finance. It is a child of the rational expectation theory applied to finance. Even though the economics profession found enough ammunition to shoot it down in monetary policy, it embraced it for financial markets. The combination led to Greenspan's monetary policy and financial supervision at the Fed for nearly two decades. He created possibly the greatest man-made economic catastrophe in human history. The world still lives under his shadow.

The real world has turned to be opposite to the favored positions of the economics profession: the financial market is not only inefficient but systematically bubble-prone, and monetary stimulus has abetted in bubble creation and its growth impact is merely the bubble spillover. Greenspan managed the U.S. economy largely through building up asset bubbles, even though he may have believed otherwise. As the U.S. dollar is the reserve currency for the global economy, Greenspan's policy was responsible for bubbles around the world.”

 

(emphasis added)

As asset prices rose under Greenspan's reign, he was widely admired as the main architect of prosperity. In the late 90's he was even referred to as the 'Maestro'. And yet, his critics never tired to point out that his credit-induced prosperity was a sham – the accounting profits created by monetary inflation would eventually be given back.

Mind, this is not the same as saying that we were poorer at the end of the boom than on its eve. Ludwig von Mises stressed that the 'impoverishment created by a boom' does not necessarily mean that a boom leads to an overall loss of wealth. After all, the market economy ceaselessly creates real wealth, even if it is severely hampered by monetary pumping, regulation, excessive taxation and government spending. If that were not the case, capitalism would not have created the progress and wealth surrounding us. The argument is rather that the boom leaves us much worse off than we would have been without it

Xie concludes that the current monetary experiment will fail to create growth, but will eventually succeed in creating 'inflation' (in the sense that prices of consumer goods will rise strongly).

We would argue that whether or not the public's inflation expectations become unmoored, leading to such an outcome (it seems e.g. possible to us that before that happens, another 'deflation scare' will strike in the form of falling asset prices), the inflationary policy has already done a lot of damage and continues to do so. It has definitely influenced prices, although not all prices to the same extent. It has thereby definitely hampered economic calculation and furthered the malinvestment of scarce capital. Resources have been diverted into economic projects that would normally not be regarded as profitable.  Even though the market economy no doubt continues to create wealth in spite of all this, there will be a price to be paid down the road. Given the sheer size of the monetary experiment now underway- at the end of 2007, money TMS-2 stood at $5,3 trillion, at the end 2012 it stood at $9,3 trillion – the price could turn out to be a steep one indeed.

 


 

TMS

US Money TMS-2, via Michael Pollaro. Enormous money supply growth has been underway since the 2008 crisis and no end is in sight yet – click for better resolution.

 


 

 

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2 Responses to “Andy Xie on Why Money Can’t Buy Growth”

  • When the true purpose of central bank monetary expansion is to cover up insolvency, it will never work. Without insolvency, it wouldn’t matter, save for creating price inflation. It is clear the current system requires inflation to exist, that only the intentional diminshing of monetary value and credit worthiness keeps a bubble system going. It appears that currently, the door is open for recovery, but only if more people agree to be led to the longer term slaughter of financial insolvency. We are enforcing a modern day slavery through maintaining the status quo in debt, the status quo in bank ownership and increasing government participation in the economy. As a result, the bulk of debt is being created to maintain debt and not productive expansion of the economy.

  • No6:

    “The fact that its effects haven’t yet shown up in consumer price indexes is not tantamount to it being harmless. ”

    Indeed. It is a direct reflection of how badly relative prices have already been distorted by the previous growth in money supply. A more rapid response in consumer prices would have been a much healthier sign. The longer the lag the more devastating the sequele.

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