Over the weekend, the top central bankers convened (some by zoom) in Jackson Hole in the US state of Kansas to discuss “Macroeconomic Policy in an Uneven Economy”.
Central bankers carry the aura of cardinals since they manage money mysteriously through creation of central bank reserves. You know how important central bankers are from the balance sheets they manage.
For nearly 25 years, the Fed’s balance sheet was around six per cent of gross domestic product (GDP). It doubled to over 15 per cent of GDP in 2008, and more than doubled again to 34.6 per cent of GDP by end-June 2021. The Bank of Japan (BOJ) is champion central bank at 132 per cent of GDP, with People’s Bank of China at 33.9 per cent and European Central Bank (ECB) 60.6 per cent. These four central banks alone accounted for $30.1 trillion in asset size or 35.5 per cent of world GDP (yardeni.com).
The Fed, BOJ and ECB together increased their balance sheet by six times from $4 trillion just before the 2008 Lehman collapse to currently $24.3 trillion. Their purchases of sovereign debt, corporate bonds, mortgage papers and equity exchange-traded funds (ETFs) move markets.
Small wonder everyone hangs (literally for hedge funds) on the words of central bankers.
Last year, the Fed chairman Jerome Powell’s keynote at Jackson Hole laid out the Federal Open Market Committee’s (FOMC) new statement on Longer-Run Goals and Monetary Policy Strategy. He highlighted four fundamental developments: US longer-run growth potential had declined; level of interest rates had fallen to historical lows; unemployment rates were well below sustainable levels; and despite low unemployment, inflation remained low and below the FOMC target of two per cent set in 2012.
Central bank speeches should be read not for what has been said, but what is not said. Former Fed chairman Alan Greenspan, worshiped by Wall Street for bailing them out by lowering interest rates, famously said: “I know you think you understand what you thought I said but I’m not quite sure you realise that what you heard is not what I meant.”
Powell’s 2020 address was revealing because the words, “wealth”, “climate change”, “race”, were not mentioned at all in his speech. “Inequality” appeared once in a footnote reference to an academic paper. Most of his speech lamented the fact that the Fed couldn’t seem to get inflation up to the target of two per cent per annum, despite tight job markets. He was comfortable that “a longer-run inflation rate of two per cent is most consistent with our mandate to promote both maximum employment and price stability”.
How is it possible that central bankers who expanded their balance sheets by $9 trillion since March 2020 deny their impact on climate change, low productivity, wealth and income inequality? Their standard answer is that these are outside their mandate of maintaining price and financial stability. The unspoken reason is the fear that if they wander outside their mandates, politicians will blame them for everything and take away their hard-won independence.
Here’s why we cannot disentangle monetary policy from climate change, low productivity and social inequality.
First, all markets are priced based on the price of money, namely the interest rate. We use the Discounted Cash Flow (DCF) model for valuation by discounting all future cash flows to its present value. The lower the interest rate, the higher the value of the asset. But when the discount rate is zero or negative, the value becomes infinity or indeterminate, which is exactly why we see bubbly asset markets everywhere.
Second, low interest rates and high liquidity reduce productivity. No one in their right mind would invest in the uncertain long-term future (investing in infrastructure or dealing with climate change) because it is so much better to speculate on asset bubbles. Speculators know that central banks would keep markets stable, ergo underwrite market shocks. Too much short-term liquidity creates the liquidity trap identified by Keynes during the 1930s Great Depression. You are trapped because investors stay liquid, rather than invest in long-term productivity-creating jobs and capital. Few are allocating capital to deal with climate change, even at very low interest rates.
Third, both wealth and income inequality worsen with lower interest rates. The rich can borrow cheaply because they have collateral, whereas the poor pay much higher interest rates because of higher credit risks. But asset inflation creates the greater wealth inequality because bubbles enable the rich to get richer, whereas the poor cannot afford even basic housing. Could stock and bonds markets be at record heights when world growth is negative during the pandemic, without $9 trillion of monetary and fiscal stimulus?
Fourth, carbon emissions come from excess human consumption, which is only possible through debt creation. Ecologists know that if every person on earth consumes like the average American, we would need four earths of natural resources. It so happens that financial assets (mostly debt) are already four times world GDP. We are depleting natural resources through consuming today, leaving our debt to be paid by future generations.
But why is there no inflation? The answer is that the bottom half of society (many in developing countries) are so desperate for income that they are selling everything cheap just to keep alive, pay for health, schooling and food bills. Like the 1930s, the rich never had it so good.
In short, the world is now so complex and entangled that we cannot separate climate change, jobs, technology, inflation and politics from financialisation. Central banks in the smaller markets already recognise the threat and South Korea is the first to signal the increase in interest rates. The Fed will not want to raise interest rates in the short-run because the Federal debt burden at 102 per cent of GDP cannot tolerate higher interest costs. Hence, everyone will be happy with status quo, keep interest rates low, and if underlying inflation runs higher than two per cent, the borrowers get their debt inflated away. Only the poor and the savers pay.
Global imbalances distorted by low interest rates have ultimately a moral cost because the negative effects are not on the one per cent but on the poor and the planet. Our cardinals of finance never worry about unemployment, because Wall Street have plenty of jobs on offer.
Andrew Sheng is a columnist for Asia News Network