The Central Banks Grand Experiment, Continued
by Sinclair Noe
DOW + 106 = 15,409
SPX + 10 = 1660
NAS + 29 = 3488
10 YR YLD + .12 = 2.13%
OIL + .88 = 95.03
GOLD – 4.90 = 1382.40
SILV – .12 = 22.37
New record highs for the Dow, not for the S&P 500.
Last week there was considerable hand wringing and flop sweat about the idea that the Federal Reserve might pull back from QE. And you may recall that I told you that I didn’t think so; we might see the Fed change the composition of the accommodative monetary policy in order to avoid particular asset bubbles, but they would not abandon a loose money policy; they might even try out some new tools.
The economic stagnation of the major developed nations has driven central banks in the United States, Japan, Britain and the European Union to take increasingly aggressive action. Because governments are not taking steps to revive economies, like increasing spending or cutting taxes, the traditional concern of central bankers that economic growth will cause too much inflation has been supplanted by the fear that growth is not fast enough to prevent deflation, or falling prices. The European Central Bank faces legal and political restraints that make it harder for the bank to imitate the other major central banks. It cannot finance governments, which limits its ability to buy any country’s bonds. Still, there has been a shift in sentiment from the ECB, including lower rates and a change in attitude away from austerity.
Both the Bank of Japan and the European Central Bank reaffirmed that their policies would remain in place. Yesterday, an executive board member of the European Central Bank said the policy would stay as long as necessary. Today, a Bank of Japan board member said it was vital to keep long- and short-term interest rates stable.
What are we learning from this global shift towards super-easy money? After years of sluggish or no growth, Japan is serving as the laboratory for this grand experiment in easy money economics. Last month, Haruhiko Kuroda, the new chairman of the Bank of Japan, steered the central bank toward a bold new policy of reinflating the Japanese economy by doubling the money supply. It is considered the boldest step so far by a central bank.
The good news is that the Japanese economy is recovering. The Japanese stock market is red hot. The bad news is that the austerity hawks and conservative pundits still want to see Abenomics — the economic policies put forward by Prime Minister Shinzo Abe on taking office last year — as a mere flash in the pan. More sizzle than steak. Yet despite some hiccups that sizzle now looks like turning into a full-fledged conflagration. Abenomics seems to be winning out against bad economics.
Perhaps the biggest mistake of the bad economists was failure to realize how much the yen depreciation triggered by Abenomics can benefit an economy. They like to point out how any boost to exporters is canceled out by losses to import-dependent industries. But even in Economics 101 we learn that currency depreciation benefits not just exporters. A large swath of domestic industries also benefit — everything from pig farmers and parts makers competing with imports to universities and tourist hotels seeking foreign customers.
It’s still too early to declare a victory for Japanese easy money. Bank of Japan monetary easing urgently needs to be reinforced by fiscal measures and new growth policies. To date, neither has offered much promise. The growth policies are not yet fleshed out and the austerity hawks are still able to kill any talk of serious fiscal stimulus.
The austerity people seem to see increased fiscal spending purely in terms of adding to national debt. But that really is bad economics. Well-chosen government spending can have multiplier effects that increase tax revenues as much as the spending increases. By the same logic, spending cuts can very easily end up cutting tax revenues to the point where the national debt increases rather than falls. This is especially true for Japan where rises and falls in asset prices strongly influence tax revenue.
In Japan, they’ve been dealing with a weak economy for so long, they’ve learned some of the moves that don’t work. The spending cuts only pushed the economy into recessions. Tax revenues fall and stay depressed despite the later spending increases to counter those recessions. Increases in national debt are spectacular. During the Koizumi years when “structural reform” was supposed to save the economy, the national debt increased by a massive 200 trillion yen, an inconvenient truth ignored by the austerity hawks.
Some austerity pundits compare Japan’s economy to a broken engine that the Keynesian planners try vainly to spark into action with the “gasoline” of fiscal stimulus. The real problem is the exact reverse. Japan already has a fine well-oiled economic machine. What it lacks is the gasoline of demand. It has been running on empty, for years, one reason being the demand-killing repairs those pundits have tried to make to that allegedly broken engine.
The austerians do have one valid point. If, thanks to Abenomics, the economy does begin to grow, then eventually interest rates are bound to rise. This rise will force a large increase in the government spending needed to service national debt. Unless that spending increase is matched by rapidly rising tax revenues, debt levels will rise even more, forcing even more debt service spending, ad infinitum.
There is an answer to this, and it may be a part of the Japanese monetary experiment. It says that provided inflation is under control governments can ignore their central banks and simply print the money they need to expand demand and service debt.
How about here in the good old USA? Well, it’s a mixed bag, but the latest survey of consumer-confidence climbed to a five-year high of 76.2 in May from a slightly revised 69.0 in April. Consumers are considerably more upbeat about future economic and job prospects. Higher stock prices, rising home values and falling gasoline costs have made Americans more upbeat. A lack of drama in Washington has also allowed consumers to regain confidence after several political disputes had threatened to harm the economy. The bad news is the politicians aren’t helping. The good news is they aren’t screwing things up, at least not this month.
And I have a follow-up to a listener who called in last Friday, asking about money laundering at the Vatican Bank. The Vatican Bank, officially called the Institute for Religious Works (IOR), manages an estimated $5 billion in assets for religious orders and Catholic charities. A private entity, its inner workings have long been shrouded in secrecy. Now, there are efforts to bring a new era of transparency to the bank. The head of the Vatican’s new Financial Intelligence Authority, disclosed Wednesday that he had found six incidents of possible money laundering in the Vatican Bank from last year. Two of the incidents were considered to be serious enough to pass to the Vatican’s prosecutor.
The Vatican Bank has a history of murky transactions, but in 2010 Italian authorities place the bank’s CEO and president under investigation for money-laundering. After that, Pope Benedict initiated the Financial Intelligence Authority to clean things up. Maybe last week’s announcement is a step in the right direction.