WHEN AND WHAT IF A “MONEY FINANCE” BOOST?
By Wilfred Hahn, Chairman & Co-CIO
Overt Money Financing (OMF) … Outright Permanent Money Finance (OPMF)? These names and acronyms may sound snoringly uninteresting to the average citizen.
Yet, we will venture to say that the above-mentioned acronyms (and likely other similar ones) will be amongst the world-wide developments over the next few years that could have the biggest impact upon your life and the society that you live in. More likely, it could be the largest of all.
We have introduced this topic before. Please see Out of the Closet: OPMF Coming at You, posted on our website. We wrote this in response to an INET presentation by Lord Adair Turner and the comment by Lucrezia Reichlin (see www.VOXEU.org) that “it makes sense to consider all options including tools that have stayed long in the closet.” Turns-of-phrase aside, one could not take this topic too seriously. Crucially, we lay out our current thinking with respect to portfolio strategy.
First, a brief update on the “Money Finance” (MF) movement.
To review, just what is the significance of “money finance?” To a growing number of economists, it is the counter-movement to the Austerians (this a word-play on the devotees to the Austrian School of economics and the austerity policies that they are likely to promote). In parallel, such economic luminaries as Paul Krugman, Nouriel Roubini and others are lending their voices to the “anti-austerity” movement which now seems to be winning the majority position. Crucially, new articles from academia are presenting the case for MF (a recent one of which we will review here).
Prospects for Austerianism are now pretty much dead. By extension, then, the MF merchants are getting increasing attention. They are likely to garner much more should economic growth remain tepid and/or new economic crisis occur. MF is the latest and most attractive monetary magic that can be sold to policymakers and taxpayers. You’ll see why it could be the crack cocaine of economic stimulus.
What is the technical attraction of Money Finance? All the high-brow endorsements aside, what MF really represents is a transfer of wealth. Effectively, MF involves the direct money injection by central banks into either governments or households (possibly in the form of tax cuts) without a corresponding liability. In other words, central banks will create new money and hand it over to those that ideally will have a high “propensity” to spend. The double-entry convention will not be discarded. Consider that the net equity position of the central bank becomes deeply negative (though the consensus here is that this would not matter) as it retires sovereign debt or suffers losses on its bond portfolio.
Can prosperity really be created out of thin air? Of course not. There are long-term side-effects to MF. After the sought-after initial “demand” boost that such policies would create, there indeed are a few potential problems with MF policies. However, the “free spending money” advocates don’t think that any of the concerns that they identify will present any hurdles.
Overlooked, however, are some potentially serious issues; these mostly being of a longer-term nature. (None of the articles we have read on this topic mentioned any serious flaws.) Firstly, we note that policymakers (most of which are unelected officials) will be deciding how to reallocate national wealth. By giving governments (and or households) free claims on money, the relative wealth distribution will be affected. It is already extreme. Secondly, policymakers seem to have little idea as to the long-term distortions of MF upon economies and societies.
Gauging from past histories of monetary malfeasance, we can surmise at least five outcomes: 1. A beginning but temporary surge of spending (this is the stage that could witness the ignition of an economic acceleration); 2. Rising goods and services costs relative to incomes (inflation?); 3. A continued polarization of the wealth distribution (a greater proportion of wealth held in fewer hands); 4. Greater societal discontent and inequity more pronounced than might otherwise have been; 5. Eventually, another financial and economic crisis perhaps of the magnitude of the Global Financial Crisis (GFC) or greater.
We can’t be entirely sure of any exact predictions, but past world history and the natural behavioural proclivities of people provide some confirmation. As pointed out, none of the potential longer-term short-comings appear to be mentioned in the presentations and research papers that the Money Finance proponents are producing. They choose to only emphasize the short-term bang. We anticipate that this will be a crucial factor impacting investment policies.
Since our earlier article on this discussion, global consensus has indeed advanced. New imperatives and potential crisis are now cited to support the advocated MF policies. A recent article written by authors Biagio Bossone and Richard Wood, makes the latest case for “money finance.” [We remember a left-wing group some twenty-five years ago seriously propounding the very same idea. At the time, they were considered laughably ignorant. How times change!] These respected macroeconomists build on previous arguments made by Ben Bernanke (yes, he did prescribe Money Finance to the Japanese in 2003), Milton Friedman, John Kenneth Galbraith …and other well-known theorists.
Here is a brief outline of the arguments and conditions supporting their case for MF policies (we quote from the referenced article liberally):
1. Countries already relying on new unorthodox policies (namely various QE programs) are still not reaching economic launch speed nor escaping deflationary tendencies. Therefore, something more is needed.
2. QE injects money to Wall-Streeters not Main-Streeters. It is not stimulating investment. Wall Streeters are preying on QE.
3. Inadequate demand is the problem even at currently low interest rate levels. Demand must be lifted.
4.There is no evidence that further QE will significantly increase business investment. So why do more? Something different is needed.
5.Current policies are only serving to create serial financial bubbles. Interest rates are giving the wrong signals.
6. Government debt levels are too high. The cost of servicing debt is straining the public purse. Greater indebtedness must be avoided.
7. The authors present the case that MF policies could work even in the EU and Eurozone (meeting Article 123 of the Lisbon Treaty). Money Finance can work from Japan, to the U.S. and U.K. … to the EU.
8. Finally … and alarmingly … global instability is increasing … not subsiding!
To this list, we add several of our own observations (though we are not advocating any policies):
9. Economic momentum is clearly slowing around the world and continues dangerously near stall speed. Any further decline would be disastrous at this stage.
10. The forward guidance of low-low interest rates “as far as the eye can see” is already fully discounted in the prices of all assets. Rates are already at the zero-bound … and have been for nearly 5 years! There is little juice left in the “wealth effect.”
11. The Keynesian Multiplier has turned negative. More debt applied through traditional monetary channels no longer produces an incremental dollar of demand.
12. Political gridlock is removing the option of funding new government spending with tax raises or new debt issuance. Money Finance can more easily be initiated with the approval of governments.
Money Finance policies, given the current and expected environment as shown, looks all so delectable and timely of a solution for the problems of the times.
Imagine being a policymaker: MF policies will seem irresistible. Consider that many of your country’s constituent households are grumbling. Real personal income is still below levels of more than a decade ago. Unemployment is high, its more unexpurgated measures suggesting that unemployment is at its highest since the Great Recession of the 1930s. The budgetary kitty is near empty. It is impossibly difficult to find money to boost the economy … to fund new infrastructure spending … to supplement low-income households …etc. Congress is grid-locked on issues such as “new” or higher taxes. The federal budget deficit is still at unprecedented highs (versus pre-GFC history). No amount of printed new money (technical monetary debates aside) is finding any traction in the real economy. There isn’t a new QE program to be conceived that can boost demand. What to do?
Along come the Money Finance consultants. They say: “We can produce money to directly credit to your government … or which can be gifted to households. It will be sure to boost economic demand. Your constituents will experience more jobs and they will gratefully again vote for you. But best of all, there will be no interest to pay and overall government debt levels will not rise. We have found the Holy Grail of money. Instead, what debt there is will magically slough away as nominal economic growth begins to spurt on the upside. It’s a win-win.”
It sounds understandably irresistible. But, doesn’t it all sound too good to be true? Everyone has heard this admonition: If it sounds too good to be true, then it ain’t true! Likewise, MF policy will not prove to be a win-win. But it does promise to be one roller coaster of a ride.
Authors Bossone and Wood make the statement that had UK instead funded new budget deficits with money finance (rather than buying existing bonds) over the past years, the added stimulus to its economy could have been as much as 26% of GDP. This would have been an incredible boost. As such, these claims show just how alluring are MF policies. Moreover, there is no doubt that they will have an impact on economic growth, one way or another. The specific outcomes will depend on the terms and channels of future Money Finance policies. Stock markets should be expected to perform favourably in such an environment. Fixed-income investments will not do so well comparatively.
Strong investment returns will not want to be missed. However, the ride may not be suitable for everyone. Why? Because gains and returns will come with somewhat higher volatility. Firstly, major Money Finance programs will likely not be initiated until further signs of economic and financial weaknesses appear. Such downturns or crises will generate the impetus for central banks and policymakers to launch these new MF solutions. This, as a consequence, drives the higher volatility. Not everyone will be fully comfortable with such conditions. Nevertheless, that is the trade-off for higher gains seen over the intermediate term.
Additionally, the tactical strategies required to capture investment returns over the initial stages of MF will at times seem to go against human nature … against the natural instincts of risk … as they already do. Traditionally, government bonds were considered to be less volatile and less risky than equities. This is no longer the case in the environment we are describing here. As such, having a higher exposure to equities will not be as risky as it seems, especially so, viewed from a longer-term perspective.
A higher bias towards equities than was the traditional convention in the past is recommended. This means both a strategic change in investment policy and portfolio design as well as tactical overweights. We anticipate that the very crises that will propel the introduction of MF policies (in turn driving higher equity returns) can be used as ideal entry points to establish the overweighted equity positions.
Overt Money Financing of Fiscal Deficits: Navigating Article 123 of the Lisbon Treaty. Authors: Biagio Bossone & Richard Wood. Posted on EconoMonitor. Accessed July 21, 2013.