The Money Press

Reprinted from the FT:

The Fed finds itself in a nasty hole

January 26, 2023

Opinion  

America’s central bank should have been quicker to tackle the risks of its post-crisis policies

Gillian Tett

There is never a good moment for the US government to hit its ceiling for debt issuance — and spark speculation about a potential looming default if Congress refuses to raise it.

Now, however, is particularly inopportune timing for this fight. That is partly because big foreign buyers have quietly trimmed their Treasury purchases in the last year, and this might accelerate if chatter about a possible default grows louder.

It is also because liquidity has repeatedly vanished from the Treasuries sector at times of stress in recent years, because of underlying vulnerabilities in the market structure. This could easily reoccur in a debt-ceiling shock, since these structural problems remain (lamentably) unaddressed.

But the biggest reason to worry about the timing is that the financial system is at a crucial stage in the monetary cycle. After 15 years of accommodative monetary policy, during which the US Federal Reserve expanded its balance sheet from $1tn to $9tn, the central bank is now trying to suck liquidity out of the system, to the tune of about $1tn a year.

This process is necessary, and long overdue. But it was always going to be difficult and dangerous. And if Congress spends the coming months convulsed by threats of default — since the Treasury’s ability to fund itself apparently runs out in June — the risks of a market shock will soar.

A recent report from the American lobby group Better Markets outlines the wider backdrop well. This entity first shot to fame during the 2008 global financial crisis when it became a thorn in the side of Wall Street and Washington regulators because it complained loudly — and correctly — about the follies of excessive financial deregulation. Since then, it has continued to scrutinise the more recondite details of US regulation, complaining, again rightly, that the rules have recently been watered down.

However, in a striking sign of the times, it now has another target in its sights: the Fed. Most notably, it thinks that the biggest danger to financial stability is not just the finer details of regulation, but post-crisis loose monetary policy. This left investors “strongly incentivised, if not forced, into [purchases of] riskier assets”, it “decoupled asset prices from risk and ignited a historic borrowing and debt binge”, the Better Markets report argues. Thus, between 2008 and 2019 the amount of US debt held by the public rose 500 per cent, non-financial corporate debt increased 90 per cent and consumer credit, excluding mortgages, jumped 30 per cent.

Then, when the Fed doubled its balance sheet in 2020 in the midst of the pandemic, these categories of debt rose by another 30, 15 and 10 per cent respectively. And the consequence of this exploding leverage is that the system is today highly vulnerable to shocks as interest rates rise and liquidity declines — even before you factor in a debt-ceiling row.

“The Fed is in many ways fighting problems of its own creation. And considering the scale of the problems, it is very difficult to solve without some damage,” the report thunders. “Although the Fed monitors and seeks to address risks to financial stability and the banking system, it simply failed to see — or didn’t look or consider — itself as a potential source of those risks.”

Fed officials themselves would dispute this, since they believe that their loose monetary policies prevented an economic depression. They might also note that rising debt is not just an American problem. One of the most stunning and oft-ignored features of the post-crisis world is that global debt as a proportion of gross domestic product jumped from 195 to 257 per cent, between 2007 and 2020 (and from about 170 per cent in 2000.)

Moreover, Fed officials would also point out, correctly, that the central bank is not a direct cause of the debt-ceiling fight. The blame here lies with political dysfunction in Congress and an insane set of Treasury borrowing rules.

But even granting those caveats, I agree with the core message from Better Markets, namely that the central bank could and should have been far more proactive in acknowledging (and tackling) the risks of its post-crisis policies, not least because this now leaves the Fed — and investors — in a nasty hole.

In an ideal world, the least bad exit from the debacle would be for Congress to abolish the debt-ceiling rules and create a bipartisan plan to get borrowing under control; and for the Fed publicly to acknowledge that it was a mistake to keep money so cheap for so long, and thus normalise ever-rising levels of leverage.

Maybe that will occur. Last week senator Joe Manchin floated some ideas about social security reform, suggesting that there might be a path to a bipartisan deal to avoid default. But if this does not emerge, the coming months will deliver rising market stress, and/or a scenario in which the Fed is forced to step in and buy Treasuries itself — yet again.

Investors and politicians would undoubtedly prefer the latter option. Indeed, many probably assume it will occur. But that would again raise the threat of moral hazard and create even more trouble for the long term. Either way, there are no easy solutions. America’s monetary chickens are coming home to roost.

gillian.tett@ft.com 

Other People’s Money

A book review of what sounds like an excellent book explaining the foundation of time, risk, and money. My comments in [Brackets].

‘The Price of Time’ Book Review: Getting Interest Rates Wrong

wsj.com/articles/the-price-of-time-book-review-a-tale-of-interest-11660318407

August 12, 2022

After the financial crisis of 2008, the dread of economic collapse gave way to yet another exuberant bull market. All sorts of asset classes—industrial commodities, house prices, stocks—soared to irrational extremes. “Never before in history had so many asset price bubbles inflated simultaneously,” Edward Chancellor writes in “The Price of Time,” a sweeping historical analysis of how our financial system once again became untethered from the world it is supposed to serve.

The Price of Time: The Real Story of Interest

By Edward Chancellor

Atlantic Monthly

At the heart of such derangement, Mr. Chancellor argues, is a single factor: artificially low interest rates. As he reminds us, interest rates are the most important signal in a market-based economy, “the universal price” affecting all others. Interest is best defined as the time value of money, which Mr. Chancellor artfully renders as “the price of time.” It is the price that informs every key financial decision—saving, spending, investing. Suppressing the rate of interest is a powerful way to boost an economy otherwise bound for recession, but it is a dangerous one. It is to finance what opiates are to medicine, a distortion of perception disguised as a cure.

[Yes, this is an excellent summation of the concept of interest. It represents the time value of money but also compounded by the risk of uncertainty over future value. I explain this more comprehensively in my short book on finance and economics, Common Cent$. All financial and economic decisions can be distilled down to the choice of whether to consume now or later. The interest rate helps to balance that choice to create an equilibrium for consumption, savings, and investment over time. A high rate leads to less present consumption and more savings and investment because the return to deferred consumption is greater. A low rate encourages the opposite: more present consumption and less saving and investment because the reward for deferring consumption is lower. The promise of new technologies will raise the rate of interest as the perceived future reward is greater. The perception of greater uncertainty and risk over those prospects also increases the rate to compensate for potential loss.]

After 2008, Mr. Chancellor notes, “central bankers pushed interest rates to their lowest level in five millennia.” The move seemed like a success at first, averting deflation and mass unemployment. But behind this immediate result lurked structural problems that the bankers had left to fester. Low rates have compounded “our current woes,” Mr. Chancellor says. These include “the collapse of productivity growth, unaffordable housing, rising inequality, the loss of market competition” and—as we may all feel right now—“financial fragility.” [Yes, we have created a fragile economy, fragile social structures, fragile political institutions, a fragile environment, and a shaky future. All unnecessarily.]

A summary of Mr. Chancellor’s argument risks reducing his fascinating work of history and analysis into a mere polemic—it is so much more than that. Mr. Chancellor, a financial journalist and the author of “Devil Take the Hindmost: A History of Financial Speculation” (1999), has seemingly read every pamphlet and treatise about interest ever written, many contradictory and most containing at least a kernel of truth. His attempt to understand our present moment sends him on a tour of ancient and modern finance, and he proves to be an engaging and instructive guide. One turns the last page of “The Price of Time” with a new and richer sense of the price that “lies at the heart of capitalism,” as Mr. Chancellor puts it.

The practice of charging interest is as old as time itself. Before Mesopotamians had learned to coin money or place wheels on carts, lenders had established the practice of demanding more in the future of whatever they made available to borrowers in the present. The etymology of many of the words for interest derive from the offspring of livestock, reflecting an awareness that wealth well managed is fruitful. But the etymology also reflects a suspicion that interest allows the rich to devour the poor. Ancient Hebrew words for interest include one meaning “the bite of a serpent.” The magic of compound interest, transforming a pittance into a fortune—has always provoked both awe and fury.

From the beginning, Mr. Chancellor shows, rulers have tried to intervene to soften the antagonism between borrowers and lenders. The earliest set of laws, Hammurabi’s code in Babylon (from around 1750 B.C.), is preoccupied with regulating interest—setting maximum loan rates, including 20% for silver and 33.33% for barley. A millennium later, Athens’s renowned lawgiver Solon ordered all the stones recording mortgages destroyed as part of an effort at moral and political renewal. (His predecessor Draco, to whom we owe the word “draconian,” had forced many debtors into slavery.) Thinkers and philosophers throughout history—from Aristotle and Aquinas to Proudhon and Marx—have regarded any rate of interest as unjust. Mere scribblers shared this view. According to Daniel Defoe, “interest of money is a canker-worm upon the tradesman’s profit.”

Diorite stela with the Code of Hammurabi. Detail showing the King standing and receiving the 282 collected laws from the God of Justice Shamash. Babylonian civilization, 18th Century BC. Paris, Musee Du Louvre (Photo by DeAgostini/Getty Images)Photo: De Agostini/Getty Images

The perception that borrowers are inherently needy and lenders greedy stubbornly persists. But whatever truth it contained in the premodern world vanished with the rise of capitalist economies. Of proto-capitalist 16th-century England, the historian R.H. Tawney wrote: “The borrower was often a merchant, who raised a loan in order to speculate on the exchanges or to corner the wool crop.” As for the lender, he might well be “an economic innocent, who sought a secure investment for his savings.”

What perceptive minds grasped in the 16th century is forgotten by those who, today, think that low interest rates necessarily promote equality. Like any other price, the rate of interest reflects a complex balance of forces in the real economy, from aggregate savings to future expectations. When governments push that price too low—or too high—they create distortions that are counterproductive and socially unjust.

In [the] past 15 years, interest rates have been pushed to near zero throughout the developed world. They even became negative in Europe and Japan. But the results, Mr. Chancellor observes, were not as distressful for the rich as a medieval canonist might have hoped. The price of securities tends to rise or fall inversely with the price of interest. [The rate of interest determines the capitalization rate of financial assets. For example, when interest rates rise, house prices go up because borrowers have more leverage. Conversely, when interest rates rise, these same asset prices must fall – which is where we get collapsing asset markets. If these markets’ prices don’t fall, we get a credit freeze.] Those who own the most securities thus benefit the most when interest rates fall. “It is no coincidence,” Mr. Chancellor writes, “that the greatest fortunes have been gained during periods of abnormally low-interest rates.” As he vividly puts it, “great whales feed off the savings plankton.”

Low interest rates don’t help the poor, who don’t have access to cheap credit. They do help people with formidable assets already, in part by making leverage more attractive. With money so cheap, financiers can boost investment returns with borrowed cash. As Louis Brandeis observed, Wall Street uses “other people’s money.” It prefers to pay as little as possible for the privilege.

Mr. Chancellor’s first objection to the manipulation of interest is therefore a moral one. “Distributive justice requires that borrowers and lenders receive an equivalence of value,” he writes. It is unjust that thrifty workers can’t earn a decent return on their savings accounts while sophisticated speculators earn fortunes from capital borrowed for free. [And some of our technocrats still don’t understand the financial roots of our increasing inequality, foolishly blaming it on the capitalism system itself.]

His second objection is at once more pragmatic and more alarming. Artificially low rates distort the decentralized decision-making process of a market economy. Without interest, he writes, “capital can’t be properly allocated and too little is saved.” Investors accept more risk in pursuit of higher returns, making future growth seem more attractive than current profits. And because interest is one of the chief costs in finance, low rates shift economic activity from “real world” enterprises to purely financial transactions. [Financialization of asset markets, like housing.] .As the Boston hedge-fund manager Seth Klarman has stated: “The idea of persistent low rates has wormed its way into everything: investor thinking, market forecasts, inflation expectations, valuation models.” [Our fiat currency regime since 1971 created the exploding hedge-fund industry.]

In pushing down interest rates, then, central banks have engaged in a form of central planning subtler and more pernicious than the discredited 20th-century variety. The failures of central planning are obvious when the state attempts to direct the entire economy, from railroads to grocery stores. Misguided monetary policy, by contrast, operates invisibly, dispersing perverse incentives and false signals throughout the financial system. “And the more we blunder, the more the system itself appears to fail, which in turn justifies further interventions,” Mr. Chancellor writes. Even worse, the more central bankers intervene, the more rigged the system seems to become. [The only correction to all this is Mr. Market bringing down the hammer at some point. It won’t be pretty and everyone will scream.]

Mr. Chancellor’s learned and engrossing history concludes with a somber warning. Compared with more heavy-handed forms of government intrusion, central bankers’ manipulation of interest rates may seem rather innocuous, and it is much less likely to provoke howling objections from ordinary citizens. But more than any other, it threatens the efficiency and integrity of the free-enterprise system. Behind the price of time is the priceless right of freedom. [Yes, what all this financial mismanagement will do is reduce our precious liberties, which won’t be felt until they’re gone.]

Mr. Rowe is a historian in Dallas.

QE4Ever

A bit like love, eh?

This article offers some good insights into monetary manipulation. The one thing I see missing is the recapitalization of assets based on depressed long-term interest rates, which is a result of Quantitative Easing and Zero Interest Rate Policy (ZIRP). So we have massive asset bubbles across many real asset classes as a result. No one seems to have any idea how this unwinds, but unwind it must.

‘Quantitative Easing’ Isn’t Stimulus, and Never Has Been

By Ken Fisher, RealClearMarkets

(AP Photo/Jose Luis Magana)

Upside down and backwards! Nearly 13 years since the Fed launched “quantitative easing” (aka “QE”), it is still misunderstood, both upside down and backwards. One major camp believes it is inflation rocket fuel. The other deems it essential for economic growth—how could the Fed even consider tapering its asset purchases amid Delta variant surges and slowing employment growth, they shriek! But both groups’ fears hinge on a fatal fallacy: presuming QE is stimulus. It isn’t, never has been and, in reality, is anti-stimulus. Don’t fear tapering—welcome it.

Banking’s core business is sooooooo simple: taking in short-term deposits to finance long-term loans. The spread between short- and long-term interest rates approximates new loans’ gross profit margins (effectively cost versus revenue). Bigger spreads mean bigger loan profits—so banks more eagerly lend more.

Overwhelmingly, people think central banks “print money” under QE. Wrong. Very wrong. Super wrong! Under QE, central banks create non-circulating “reserves” they use to buy bonds banks own. This extra demand boosts bond prices relative to what they would be otherwise. Prices and yields move inversely, so long-term interest rates fall.

Fed Chair Jerome Powell and the two preceding him wrongheadedly label QE stimulus, thinking lower rates spur borrowing—pure demand-side thinking. Few pundits question it, amazingly. But economics hinges on demand … and supply. Central bankers almost completely forget the latter—which is much more powerful in monetary matters. These “bankers” ignore banking’s core business! When short-term rates are pinned near zero, lowering long rates shrinks spreads (“flattening” the infamous yield curve). Lending grows less profitable. So guess what banks do? They lend less! Increase demand all you want—if banks lack incentive to actually dish out new loans, it means zilch.  Stimulus? In any developed world, central bank-based system, so-called “money creation” stems from the total banking system increasing net outstanding loans. QE motivates exactly the opposite.

Doubt it? Consider recent history. The Fed deployed three huge QE rounds after 2008’s financial crisis. Lending and official money supply growth shriveled. In the five pre-2008 US expansions, loan growth averaged 8.2% y/y. But from the Fed’s first long-term Treasury purchases in March 2009 to December 2013’s initial taper, loan growth averaged just 0.8% y/y. After tapering nixed the nonsense, it accelerated, averaging 5.8% until COVID lockdowns truncated the expansion. While broad money supply measures are flawed, it is telling that US official quantity of money grew at the slowest clip of any expansion in history during QE.

Now? After a brief pop tied to COVID aid, US lending has declined in 12 of the last 14 months. In July it was 4.7% above February 2020’s pre-pandemic level—far from gangbusters growth over a 17-month span.

Inflation? As I noted in June, it comes from too much money chasing too few goods and services worldwide. By discouraging lending, QE creates less money and decreases inflation pressure. You read that right: QE is disinflationary. Always has been. Wherever it has been tried and applied inflation has been fried. Like Japan for close to …ah…ah…ah….forever. Demand-side-obsessed “experts” can’t see that. But you can! Witness US prices’ measly 1.6% y/y average growth last expansion. Weak lending equals weak real money growth and low inflation—simple! The higher rates we have seen in recent months are all about distortions from lockdowns and reopenings—temporary.

The 2008 – 2009 recession was credit-related, so it was at least conceivable some kind of central bank action might—maybe kinda sorta—actually help. Maybe! But 2020? There was zero logic behind the Fed and other central banks using QE to combat COVID. How would lowering long rates stoke demand when lockdowns halted commerce?

It didn’t. So fearing QE’s wind-down makes absolutely no sense. Tapering, other things equal, would lift long-term rates relative to short rates—juicing loans’ profitability. Banks would lend more. Growth would accelerate. Stocks would zoom! Almost always when central banks try to get clever they wield a cleaver relative to what they desire.  A lack of FED action is what would otherwis be called normalcy.

Fine, but might a QE cutback still trigger a psychological freak-out, roiling markets? Maybe—briefly. Short-term volatility is always possible, for any or no reason. But it wouldn’t last. Tapering is among the most watched financial stories—has been for months. Pundits over-worry about it for you. Their fretting largely pre-prices QE’s end, so you need not sweat it. This is why Powell’s late-August Jackson Hole commentary—as clear a statement that tapering is near as Fed heads can make—didn’t stoke market swings. The ECB’s September 9 “don’t call it a taper” taper similarly did little. Remember: Surprises move markets materially. Neither fundamentals nor sentiment suggest tapering is bear market fuel.

Not buying it? Look, again, at history. The entrenched mythological mindset paints 2013’s “Taper Tantrum” as a game-changer for markets. Untrue! After then-Fed Chairman Ben Bernanke first hinted at tapering back in May 2013, long-term Treasury bond prices did sink—10-year yields jumped from 1.94% to 3.04% by that yearend. But for US stocks, the “tantrum” amounted to a -5.6% decline from May 21 through late June—insignificant volatility. After that, stocks shined. By yearend, the S&P 500 was up 12.2% from pre-taper-talk levels. Stocks kept rising in 2014 after tapering began. 10-year yields slid back to 2.17%. My sense is even tapering’s teensy impact then is smaller this time because, whether people consciously acknowledge it or not, we all saw this movie before.

Taper terror may well worsen ahead of each coming Fed meeting until tapering actually arrives. Any disappointing economic data will spark cries of “too soon!” Tune them down. History and simple logic show QE fears lack the power to sway stocks for long.

Ken Fisher, the founder, Executive Chairman and co-CIO of Fisher Investments, authored 11 books and is a widely published global investment columnist.

Funny Money: BTC or US$?

I recently read or heard various critics of Bitcoin compare it unfavorably to the US dollar. This short article explains why fundamentally they are not that different. Each relies on the trust people have in the currency to be able to use it as a store of value or a medium of exchange. Trust can be fractured in either case. The main difference between crypto and fiat currency is the fact that governments usually demand that we pay taxes in the national currency, but that can easily change. Crypto has the added trust factor in that it doesn’t rely on the prudence of politicians.

The true cost of make-believe money

spectator.us/topic/true-cost-make-believe-moneyEconomics

Biden commands trillions in the way previous presidents have commanded billions

by Lionel Shriver

May 6, 2021 | 8:24 am

I like Bill Maher. He’s a rare practicing left-wing comic who’s actually funny. But last week, his routine on cryptocurrency hit eerie harmonics.

‘I fully understand that our financial system isn’t perfect, but at least it’s real,’ he began. By contrast, crypto is ‘just Easter bunny cartoon cash. I’ve read articles about it. I’ve had it explained to me. I still don’t get it, and neither do you’.

Bitcoin is ‘made up out of thin air’ and is comparable with ‘Monopoly money’. As for conventional legal tender: ‘We knew money had to originate from and be generated by something real, somewhere. Cryptocurrency says, “No, it doesn’t”… Or as another analyst put it, “It’s an open Ponzi scheme”. It’s like having an imaginary best friend who’s also a banker.

‘Our problem here is at root not economic but psychological. People who have been raised in a virtual world are starting to believe they can really live in it. Much of warfare is a video game now; why not base our economy the same way? Cryptocurrency is literally a game.

‘Do I need to spell this out? There is something inherently not credible about creating hundreds of billions in virtual wealth, with nothing ever actually being accomplished, and no actual product made or service rendered. It’s like Tinkerbell’s light. Its power source is based solely on enough children believing in it.’

That monologue was broadcast in the same week Joe Biden promoted the third of his gargantuan spending programs, bringing his first 100 days’ total discretionary spending proposals to $6 trillion. (Context: total US GDP is $21 trillion.) This lavish largesse would be slathered atop the annual (and growing) nondiscretionary budget of nearly $5 trillion, against $3.5 trillion in tax revenue. Let’s tweak Maher’s routine, then:

‘I fully understand that our financial system isn’t perfect, but at least, or so I’ve imagined, it’s real. But the American dollar increasingly resembles Easter bunny cartoon cash. I’ve read articles about Modern Monetary Theory. I’ve had it explained to me. I still don’t get it, and neither do you.

‘Dollars are now made up out of thin air and comparable with Monopoly money. We thought we knew that money had to originate from and be generated by something real, somewhere. Modern Monetary Theory says, “No, it doesn’t”… Or as another analyst put it, “Quantitative easing is an open Ponzi scheme”. The Federal Reserve is like having an imaginary best friend who’s also a banker.

‘Our problem here is at root not economic but psychological. People who have been raised in a virtual world are starting to believe they can really live in it. Much of warfare is a video game now; why not base our economy the same way? The conjuring of “borrowed” money from ether, only to have that debt swallowed by a central bank and disappear, is literally a game.

‘Do I need to spell this out? There is something inherently not credible about the Fed creating not just hundreds of billions, but trillions in wealth, with nothing ever actually being accomplished, and no actual product made or service rendered. It’s like Tinkerbell’s light. Its power source is based solely on enough infantilized citizens believing in it.’

Somehow that monologue isn’t as funny in the second version.

While Maher decries the electricity squandered on crypto ‘mining’, at least the color of the Fed’s money is genuinely green. Tap a few keys, and voilà: trillions from pennies on the energy bill. So in the past year, the Fed effortlessly increased the world’s supply of dollars by 26 percent and is on track for a similar surge in 2021. But is drastic monetary expansion truly without cost?

I’ve made Maher’s Tinkerbell analogy myself, but to explain how traditional currency functions. I noted in an essay accompanying my novel The Mandibles, about America’s 2029 economic apocalypse: ‘Currency is a belief system. It maintains its value the way Tinkerbell is kept aloft by children believing in fairies in Peter Pan.’

In the novel, a fictional economics professor pontificates: ‘Money is emotional. Because all value is subjective, money is worth what people feel it’s worth. They accept it in exchange for goods and services because they have faith in it. Economics is closer to religion than science. Without millions of individual citizens believing in a currency, money is colored paper. Likewise, creditors have to believe that if they extend a loan to the US government they’ll get their money back or they don’t make the loan in the first place. So confidence isn’t a side issue. It’s the only issue.’

My confidence is going wobbly. Biden commands trillions the way previous presidents have commanded billions, while the public is so dazzled by zeros that they don’t know the difference.

I’ve my quibbles with the particulars. Spending in inconceivable quantity courts waste and fraud. Biden’s American Families Plan casts so many freebies upon the waters as to constitute a de facto universal basic income, and government dependency doesn’t seem characteristic of a good life. Pandemic-relief unemployment supplements (which many Democrats would make permanent) are so generous that small businesses can’t find employees willing to work even for two to three times the minimum wage. Biden is effectively reversing Clinton-era welfare reforms, which moved so many poor Americans from state benefits to self-respecting employment. Financing all these goodies by hiking corporate taxes is popular, but only because few people realize that every-one pays corporate taxes through lower pension-fund returns, job losses from corporate flight, lower wages and higher prices.

But it’s the bigger picture that unnerves me. Zero interest rates have installed an accelerating debt loop. Governments, companies and individuals borrow because money is free. Central banks won’t raise interest rates, lest the cost of servicing all this burgeoning debt bankrupt the debtors. Governments, companies and individuals borrow still more because money is free. The Federal Reserve has already announced it won’t raise interest rates even if inflation climbs, while refusing to cite what level inflation would have to hit before reconsidering. I’ve plotted this story before. It doesn’t end well.

Real Estate Gold

This article published in Bloomberg should give us pause, because it’s not only in China where real estate leverage has become too big to fail. (And our POTUS is a real estate magnate.) In the aftermath of the financial crisis of 2008, real estate portfolios were not allowed to fail and Fed credits were used to protect excessive investment. Now we have a stark divide in the fundamental values of real estate versus the inflated prices of a product that is tax-subsidized and priced solely on the margin. As a speculative trading asset rather than basic shelter, housing has now become the tail that wags the dog of our lives. This is pretty insane, and plants us back in the age of land feudalism.

The problem, which is not only a US problem but a global one, is excess cheap credit that has led to a generational credit-debt bubble in the private and public sectors. It promotes the imbalance between China and the rest of the world and drives inequality world-wide. It reflects coordinated central bank policy under the leadership of the US Federal Reserve that was made possible by the untethering of fiat currencies – giving governments world-wide discretion over the value of their currencies.  We’ve tried to grow faster than our productivity warrants. It has greatly increased systemic risk, price volatility, and uncertainty over price signals. For example, what is a house really worth? $100K of materials or $5 million based on the marginal value of land? Or how much somebody can borrow against it?

Ultimately, the value of scarce land will have to be taxed accordingly, an idea put forth by Henry George more than a century ago.

Evergrande Is Too Big to Fail Thanks to Its Huge Land Holdings

China’s Most Indebted Firm Is Too Big to Fail

This property developer is borrowing even more to expand into unlikely projects, such as electric vehicles. But there’s a method to the madness.

By

Nisha Gopalan

September 2, 2019, 5:02 PM PDT

There’s a lot working against China’s most indebted property firm. China Evergrande Group is sitting on $113.7 billion in debt and its core profit fell 45% in the first half of the year. Real-estate growth is slowing, with banks under orders to curb home loans. President Xi Jinping’s refrain that houses are for living in, not speculation, has been cropping up more frequently. 

Time to rein things in, right? Not Evergrande. The company, whose portfolio already includes theme parks and a football club, now wants to become the world’s biggest electric-vehicle maker in the next three to five years. It’s burning through precious cash – 160 billion yuan ($22 billion) – to build factories in Guangzhou. 

Investors are voting on this folly with their feet. The company’s shares have fallen 30% this year, making Evergrande the worst performer among Hong Kong-listed Chinese developers. The property firm’s borrowing costs are among the highest in the offshore dollar market and its bonds are tumbling.  

For anyone gawking at Evergrande’s improbably ballooning debt load, just waiting for the doomsday clock to strike midnight, there’s a valuable lesson: This firm is too big to fail. Evergrande is one of China’s biggest developers – with projects in 226 cities – and its billionaire founder, Hui Ka Yan, is the country’s third-richest man. With property accounting for about a quarter of China’s gross domestic product, any instability in the sector has proven too much for Beijing to stomach. Time and again, the government has reluctantly reopened the credit spigots to boost a flagging real-estate market. Just look at 2008, 2011 and 2014. [As we have in the US, leading to a big gap between those who own real estate and those who rent or would like to buy.]

Crucially, Evergrande has China’s largest land reserve, with 276 million square meters (905 million square feet) of gross floor area, according to Citigroup Inc. While the developer has a lot of exposure to China’s smaller cities, where growth is slowing rapidly, it also dominates redevelopment in big, rich cities such as Shenzhen, where profit margins are robust. 

Land is scarce in Shenzhen, and urban renewal – demolishing old, low-density buildings to make way for high-rise apartments – is widely seen as the answer to the city’s growing population. These projects also give Evergrande access to cheap lots, which helps keep its land costs among the lowest of its peers, according to Toni Ho, an analyst at RHB Securities. If the protests in Hong Kong accelerate China’s plans to make Shenzhen the the next “global cosmopolis,” according to state-run Xinhua News Agency, Evergrande could be in a plum position.

The company’s diversification into electric cars is sure to bleed money for years, and competition is getting stiffer. During his visit to China last week, Elon Musk managed to score a tax break for Tesla Inc. But carrying out one of Xi’s signature projects has its perks: For example, clean-car manufacturers can get land much more cheaply from local governments than real-estate developers. That helps explain why a host of firms including Country Garden Holdings Co. and Agile Group Holdings Ltd. are jumping in.

Being in Beijing’s favor and securing low-cost inputs is no bad thing for a cash-strapped developer like Evergrande. Maybe there’s a method to the madness of its wild spending.

The Gig Economy (sic)

The Gig Economy has merely exposed the lie that our labor is the most valuable asset we own. Rather, our man-hours have been depreciated drastically in the last 50 years. Much of this has been due to the explosion in capital credit after the abandonment by Nixon in 1971 of the gold peg under the Bretton Woods international monetary regime. This has led to capital-labor substitution, technological innovation, and productivity increases that have reduced the demand for labor, both skilled and unskilled. It’s made some of us richer.

The second contributing factor has been capital mobility under globalization and the liberalization of the populations of the developing world. This has led to a vast increase in the supply of both skilled and unskilled labor. China and India, for the past 30 years, but we still have Africa and South America in the pipeline. 

The combined effect of these policies and geopolitical trends has driven the marginal price of labor down towards the subsistence level. We need to think outside this shrinking box. Btw, union organization will do nothing to reverse these trends unless the focus is not on controlling the supply of labor and artificially raising wages. Asset ownership, risk sharing, and personal data ownership are key.

(Note: We can’t really expect Vanity Fair to tackle these issues.)

“What Have We Done?”: Silicon Valley Engineers Fear They’ve Created a Monster

Vanity Fair

 

Gig-economy companies like Uber and Instacart are on the verge of overtaking the traditional economy. And the only people who understand the threat are the ones enabling it.

By

Susan Fowler

August 9, 2018

 

In the heart of San Francisco, the gig economy reigns supreme. Walk into a grocery store, and a large number of shoppers you see are independent contractors for grocery-delivery start-up Instacart. Step outside, and cars with black-and-white Uber stickers or flashing Lyft dashboard lights are sitting, hazards on, blocking the bike lane as they wait for passengers. Cyclists zigzag around the cars, many hauling bags branded with various logos—Caviar, Postmates, Uber Eats—as they deliver food to customers around the city. You can stand on a street corner and count the number of gig-economy workers walking by, as I often do; sometimes it’s 2 out of every 10. On some corners, like the one near the Whole Foods on 4th and Harrison, I’ve counted 8 out of every 10.

The gig-economy ecosystem was supposed to represent the promised land, striking a harmonious egalitarian balance between supply and demand: consumers could off-load the drudgery of commuting or grocery shopping, while workers were set free from the Man. “Set your own schedule,” touts the Uber-driver Web site; “Be your own boss,” tempts Lyft; “Make an impact on people’s lives,” lures Instacart. These companies have been wildly successful: Uber, perhaps the most notorious, is also the most valuable start-up in the U.S., reportedly worth $72 billion. Lyft is valued at $11 billion, and grocery delivery start-up Instacart is valued at just over $4 billion. In recent months, however, a spate of lawsuits has highlighted an alarming by-product of the gig economy—a class of workers who aren’t protected by labor laws, or eligible for benefits provided to the rest of the nation’s workforce—evident even to those outside the bubble of Silicon Valley. A July report commissioned by the New York City Taxi and Limousine Commission found that 85 percent of New York City’s Uber, Lyft, Juno, and Via drivers earn less than $17.22 an hour. When the California Supreme Court ruled in May that delivery company Dynamex must treat its gig workers like full-time employees, Eve Wagner, an attorney who specializes in employment litigation, predicted to Wired, “The number of employment lawsuits is going to explode.”

Of course, the threads of this disillusionment are woven into the very structure that has made these start-ups so successful. A few weeks into my tenure at Uber, where I started as a software developer just a year after graduating from college, still blindly convinced I could make the world a better place, a co-worker sat down next to my desk. “There’s something you need to know,” she said in a low voice, “and I don’t want you to forget it. When you’re writing code, you need to think of the drivers. Never forget that these are real people who have no benefits, who have to live in this city, who depend on us to write responsible code. Remember that.”

I didn’t understand what she meant until several weeks later, when I overheard two other engineers in the cafeteria discussing driver bonuses—specifically, ways to manipulate bonuses so that drivers could be “tricked” into working longer hours. Laughing, they compared the drivers to animals: “You need to dangle the carrot right in front of their face.” Shortly thereafter, a wave of price cuts hit drivers in the Bay Area. When I talked to the drivers, they described how Uber kept fares in a perfectly engineered sweet spot: just high enough for them to justify driving, but just low enough that not much more than their gas and maintenance expenses were covered.

Those of us on the front lines of the gig economy were the first to spot and expose its flaws—two months after leaving Uber, I wrote a highly publicized account of my time there, describing the company’s toxic work environment in detail. Now, as Silicon Valley struggles to come to terms with its corrosive underpinnings, a new vein of disquiet has wormed its way into the Slack chats and happy-hour outings of low-level rank-and-file engineers, spurred by a question that seems to drown out everything else: What have we done? It’s a question that I, too, have been forced to grapple with as I notice how my job as a software engineer has changed the nature of work in general—and not necessarily for the better.

The risk, we agreed, is that the gig economy will become the only economy.

Gig-economy “platforms,” as they’re called, take their inspiration from software engineering, where the goal is to create modular, scalable software applications. To do this, engineers build small pieces of code that run concurrently, dividing a task into ever smaller pieces to conquer it more efficiently. Start-ups function in a similar way; tasks that used to make up a single job are broken down into the smallest possible code pieces, then partitioned so those pieces can be accomplished in parallel. It’s been a successful approach for start-ups for the same reason it’s a successful approach to writing code: it is perfectly, beautifully efficient. Across so-called platforms, there are no individuals—no bosses delegating tasks. Instead, various algorithms run on the platform, matching consumers with workers, riders with the nearest driver, and hungry customers with delivery people, telling them where to go, what to do, and how to do it. Constant needs and their quick solutions all hummingly, perpetually aligned.

By now it’s clear that these companies represent more than a trend. Though it’s difficult to accurately determine the size of the gig economy—estimates range from 0.7 to 34 percent of the national workforce—the number grows with each new start-up that figures out how to break down another basic task. There’s a relatively low risk associated with launching gig-economy companies, start-ups that can engage in “a kind of contract arbitrage” because they “aren’t bearing the corporate or societal cost, even as they reap fractional or full-time value from workers,” explains Seattle-based tech journalist Glenn Fleishman. Thanks to this buffer, they’re almost guaranteed to multiply. As the gig economy grows, so too does the danger that engineers, in attempting to build the most efficient systems, will chop and dice jobs into pieces so dehumanized that our legal system will no longer recognize them. [Note: yes, labor contracts will be obsolete and meaningless, which means asset ownership is the only defensible right.] And along with this comes an even more sinister possibility: jobs that would and should be recognizable—especially supervisory and management positions—will disappear altogether. If a software engineer can write a set of programs that breaks a job into smaller increments, and can follow it up with an algorithm that fills in as the supervisor, then the position itself can be programmed to redundancy.

A few months ago, a lunchtime conversation with several friends turned to the subject of the gig economy. We began to enumerate the potential causes of worker isplacement—things like artificial intelligence and robots, which are fast becoming a reality, expanding the purview of companies such as Google and Amazon. “The displacement is happening right under our noses,” said a woman sitting next to me, another former engineer. “Not in the future—it’s happening now.”

“What can we do about it?” someone asked. Another woman replied that the only way forward was for gig-economy workers to unionize, and the table broke out into serious debate [Labor contracts, union or otherwise, will be legally ill-defined and indefensible]. Yet even as we roundly condemned the tech world’s treatment of a vulnerable new class of worker, we knew the stakes were much higher: high enough to alter the future of work itself, to the detriment of all but a select few. “Most people,” I said, interrupting the hubbub, “don’t even see the problem unless they’re on the inside.” Everyone nodded. The risk, we agreed, is that the gig economy will become the only economy, swallowing up entire groups of employees who hold full-time jobs, and that it will, eventually, displace us all. The bigger risk, however, is that the only people who understand the looming threat are the ones enabling it. 

Financial Moral Hazard

If we believe this Houdini act then we have only ourselves to blame.

How Many Bank Bailouts Can America Withstand?

The architects of the 2008 rescues pretend they’ve been vindicated.

By

James Freeman

WSJ, Sept. 18, 2018 1:56 p.m. ET

Ten years after the financial crisis of 2008, the architects of the bailouts are still describing their taxpayer-backed rescues of certain financial firms as great products which were poorly marketed to the American people. The American people still aren’t buying.

A decade ago, federal regulators were in the midst of a series of unpredictable and inconsistent interventions in the financial marketplace. After rescuing creditors of the investment bank Bear Stearns and providing a partial rescue of its shareholders in March of 2008, the feds then shocked markets six months later by allowing the larger Lehman Brothers to declare bankruptcy. Then regulators immediately swerved again to take over insurer AIG and use it as a vehicle to rescue other financial firms.

Within days legislative drafts were circulating for a new bailout fund that would become the $700 billion Troubled Asset Relief Program. Throughout that fall of 2008 and into 2009, the government continued to roll out novel inventions to support particular players in the financial industry and beyond. Some firms received assistance on better terms than others and of course many firms, especially small ones outside of banking, received no help at all.

In the fall of 2008, Ben Bernanke chaired the Federal Reserve, Timothy Geithner ran the New York Fed and Hank Paulson served as U.S. Treasury secretary. Looking back now, the three bailout buddies have lately been congratulating themselves for doing a dirty but important job. They recently wrote in the New York Times:

Many of the actions necessary to stem the crisis, including the provision of loans and capital to financial institutions, were controversial and unpopular. To us, as to the public, the responses often seemed unjust, helping some of the very people and firms who had caused the damage. Those reactions are completely understandable, particularly since the economic pain from the panic was devastating for many.

The paradox of any financial crisis is that the policies necessary to stop it are always politically unpopular. But if that unpopularity delays or prevents a strong response, the costs to the economy become greater. We need to make sure that future generations of financial firefighters have the emergency powers they need to prevent the next fire from becoming a conflagration.

The authors say that their actions saved the United States and the world from catastrophe, but of course this claim cannot be tested. We’ll never get to run the alternative experiment in which investors and executives all have to live with the consequences of their investments. But Stanford economist John Taylor has made the case that massive ad hoc federal interventions were among the causes of the conflagration. On the fifth anniversary of the crisis he noted that in 2008 markets deteriorated as the government was taking a more active role in the financial economy, which may have contributed to a sense of panic:

…the S&P 500 was higher on September 19—following a week of trading after the Lehman Brothers bankruptcy—than it was on September 12, the Friday before the bankruptcy. This indicates that some policy steps taken after September 19 worsened the problem… Note that the stock market crash started at the time TARP was being rolled out… When former Treasury Secretary Hank Paulson appeared on CNBC on the fifth anniversary of the Lehman Brothers failure, he said that the markets tanked, and he came to the rescue; effectively, the TARP saved us. Appearing on the same show minutes later, former Wells Fargo chairman and CEO Dick Kovacevich—observing the same facts in the same time—said that the TARP… made things worse.

CNBC reported at the time on its Kovacevich interview:

TARP caused the crisis to get “much greater,” he added.

“Shortly after TARP, the stock market fell by 40 percent,” he continued. “And the banking industry stocks fell by 80 percent. How can anyone say that TARP increased the confidence level of an industry, when its stock market valuation fell by 80 percent.”

Perhaps the argument can never be resolved. What is known but is conveniently left out of the Times op-ed is an acknowledgment of the role that regulators played in creating the crisis by encouraging financial firms to invest in mortgage debt, to operate with high leverage and to expect help in a crisis. The Times piece includes no mention of Mr. Bernanke and his Fed colleagues holding interest rates too low for too long, or the massive risks at Citigroup overseen by Mr. Geithner’s New York Fed, or the mortgage bets at AIG approved by the Office of Thrift Supervision at Mr. Paulson’s Treasury Department.

Foolish regulators creating bad incentives was nothing new, though Beltway blunders had rarely if ever occurred on such a scale. What was of course most shocking for many Americans in 2008 was observing so many of their tax dollars flowing into the coffers of large financial institutions. For months both the financial economy and the real economy suffered as Washington continued its ad hoc experiments favoring one type of firm or another.

In 2009 markets began to recover and, thanks in no small part to years of monetary expansion by the Federal Reserve, stock investors enjoyed a long boom. But when it comes to economic growth and wages for the average worker there was no such boom, just an era of discouraged Americans leaving the labor force. And by keeping interest rates near zero for years, the Fed punished savers and enabled an historic binge of government borrowing.

That federal borrowing binge was also enabled by the rescue programs. The basic problem was that once Washington said yes to bailing out large financial houses, politicians could hardly say no to anyone else. It was no coincidence that just months after enacting the $700 billion TARP, lawmakers enacted an $800 billion stimulus plan. So began the era of trillion-dollar annual deficits. Since the fall of 2008, federal debt has more than doubled and now stands at more than $21 trillion.

The expansion of government also included record-setting levels of regulation, which limited economic growth. A financial economy heavily distorted by federal housing policy was cast as the free market that failed, and decision-making affecting every industry was further concentrated in Washington.

Messrs. Bernanke, Geithner and Paulson make the case that they saved the financial system but failed to sell the public on the value of their interventions. It’s a sale that can never be made. Even if the bailouts hadn’t led to an era of diminished opportunity and skyrocketing federal debt, Americans would have resisted the idea that our system requires occasional instant welfare programs for wealthy recipients chosen by un-elected wise men.

The bailout buddies are now urging the creation of more authorities for regulators to stage future bailouts. The Trump administration should do the opposite, so that bank investors finally understand they will get no help in a crisis.

This column isn’t sure how many bailouts of financiers the American political system can withstand but is certain that such efforts will never be welcomed by non-financiers.

***

A Financial Crisis Is Coming?

A provocative article in USNWR. We’ve been warning about unsustainable asset prices built on unsustainable debt leverage for the past 8 years (which only means we were waaaaay too early, but not necessarily wrong!) For all this time we’ve been focused on growing total debt to GDP ratios, which means we’re not getting much bang for all that cheap credit, trying to borrow and spend our way to prosperity.

The PE ratios of equities and housing reflect a disconnect with fundamental values based on decades of market data. For example, one cannot really pay 8-10x income on residential housing for long, or pay near to 50% of income on rents, as many are doing in our most pricey cities.

Nose-bleed asset prices on everything from yachts to vacation homes to art and collectibles to technology stocks and cryptocurrencies are indicative of excessive global liquidity. Soaking up that liquidity to return to long-term trend lines will be a long, jarring process. Nobody really knows whence comes the reckoning since we have perfected a particularly successful strategy of kicking the can down the road.

A Crisis Is Coming

All the ingredients are in place for a catastrophic economic and financial market crisis.

By Desmond Lachman Opinion Contributor USNWR, Feb. 14, 2018, at 7:00 a.m.

MY LONG CAREER AS A macro-economist both at the IMF and on Wall Street has taught me that it is very well to make bold macroeconomic calls as long as you do not specify a time period within which those calls will occur. However, there are occasions, such as today, when the overwhelming evidence suggests that a major economic event will occur within a relatively short time period. On those occasions, it is very difficult to resist making a time-sensitive bold economic call.

 

So here goes. By this time next year, we will have had another 2008-2009 style global economic and financial market crisis. And we will do so despite Janet Yellen’s recent reassurances that we would not have another such crisis within her lifetime.

 

There are two basic reasons to fear another full-blown global economic crisis soon: The first is that we have in place all the ingredients for such a crisis. The second is that due to major economic policy mistakes by both the Federal Reserve and the U.S. administration, the U.S. economy is in danger of soon overheating, which will bring inflation in its wake. That in turn is all too likely to lead to rising interest rates, which could very well be the trigger that bursts the all too many asset price bubbles around the world.

A key ingredient for a global economic crisis is asset price bubbles and credit risk mispricing. On that score, today’s financial market situation would appear to be very much more concerning than that on the eve of the September 2008 Lehman-bankruptcy. Whereas then, asset price bubbles were largely confined to the U.S. housing and credit markets, today, asset price bubbles are more pervasive being all too much in evidence around the globe.

 

It is not simply that global equity valuations today are at lofty levels experienced only three times in the last one hundred years. It is also that we have a global government bond market bubble, the serious mispricing of credit risk in the world’s high yield and emerging market corporate-bond markets and troublesome housing bubbles in major economies like Canada, China, and the United Kingdom.

 

Another key ingredient for a global economic crisis is a very high debt level. Here too today’s situation has to be very concerning. According to IMF estimates, today the global debt-to-GDP level is significantly higher than it was in 2008. Particularly concerning has to be the fact that far from declining, over the past few years Italy’s public debt has risen now to 135 percent of GDP. That has to raise the real risk that we could have yet another round of the Eurozone debt crisis in the event that we were to have another global economic recession.

 

Today’s asset price bubbles have been created by many years of unusually easy global monetary policy. The persistence of those bubbles can only be rationalized on the assumption that interest rates will remain indefinitely at their currently very low levels. Sadly, there is every reason to believe that at least in the United States, the period of low interest rates is about to end abruptly due to an overheated economy.

The reason for fearing that the U.S. economy will soon overheat is not simply that it is currently at or very close to full employment and growing at a healthy clip. It is rather that it is also now getting an extraordinary degree of monetary and fiscal policy stimulus at this very late stage of the cycle.

Today, U.S. financial conditions are at their most expansionary levels in the past 40 years due to the combination of very low interest rates, inflated equity prices and a weak dollar. Compounding matters is the fact that the U.S. economy is now receiving a significant pro-cyclical boost from the unfunded Trump tax cut and from last week’s two-year congressional spending pact aimed at boosting military and disaster-relief spending.

 

Today, in the face of an overheated U.S. economy, the Federal Reserve has an unenviable choice. It can either raise its interest rate and risk bursting the global asset price bubble, or it can delay its interests rate decision and risk incurring the wrath of the bond vigilantes who might sense that the Federal Reserve is not serious about inflation risk. In that event, interest rates are apt to rise in a disorderly fashion, which could lead to the more abrupt deflating of the global asset bubble.

 

This time next year, it could very well turn out that today’s asset price bubbles will not have burst and we will not have been thrown into another global economic recession. In which event, I will admit that I was wrong in having been too pessimistic about the global economic outlook. However, I will fall back on the defense that all of the clues were pointing in the opposite direction.

QE Pains and Gains

Reprinted from Bloomberg.

The Unintended Consequences of Quantitative Easing

Asset inflation doesn’t have to be bad. Flush governments could invest in education and infrastructure.

By

Jean-Michel Paul

August 21, 2017, 11:00 PM PDT

Quantitative easing, which saw major central banks buying government bonds outright and quadrupling their balance sheets since 2008 to $15 trillion, has boosted asset prices across the board. That was the aim: to counter a severe economic downturn and to save a financial system close to the brink. Little thought, however, was put into the longer-term consequences of these actions.

From 2008 to 2015, the nominal value of the global stock of investable assets has increased by about 40 percent, to over $500 trillion from over $350 trillion. Yet the real assets behind these numbers changed little, reflecting, in effect, the asset-inflationary nature of quantitative easing. The effects of asset inflation are as profound as those of the better-known consumer inflation.

Consumer price inflation erodes savings and the value of fixed earnings as prices rise. Aside from the pain consumers feel, the economy’s pricing signals get mixed up. Companies may unknowingly sell at a loss, while workers repeatedly have to ask for wage increases just to keep up with prices. The true losers though are people with savings, which see their value in real purchasing power severely diminished.

John Maynard Keynes famously said that inflation is a way for governments to “confiscate, secretly and unobserved, an important part of the wealth of their citizens.” Critically, inflation creates much social tension: “While the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at the confidence in the equity of the existing distribution of wealth.”

Asset inflation, it turns out, is remarkably similar. First, it impedes creative destruction by setting a negative long-term real interest rate. This allows companies that no longer generate enough income to pay a positive return on capital to continue as usual rather than being restructured. Thus the much-noted growth of zombie companies is one consequence of asset price inflation. Thus also the unreasonable leverage and price observed in real estate, with the credit risks it entails for the future.

Second, it also generates artificial winners and losers. The losers are most found among the aging middle class, who, in order to maintain future consumption levels, will now have to increase their savings. Indeed, the savings made by working people on stagnant wages effectively generates less future income because investable assets are now more expensive. The older the demographics, the more pronounced this effect. Germany, for instance, had a contraction of nearly 4 percent of gross domestic product in consumer spending from 2009 to 2016.

The winners are the wealthy, people with savings at the beginning of the process, who saw the nominal value of their assets skyrocket. But, as with consumer inflation, the biggest winner is the state, which now owns through its monetary authority, a large part of its own debt, effectively paying interest to itself, and a much lower one at that. For when all is accounted for, asset inflation is a monetary tax.

The most striking similarity between consumer price inflation and asset inflation is its potential to cause social disruption. In the 1970s workers resorted to industrial action to bargain for wage increases in line with price increases.

Today, the weakened middle class, whose wages have declined for decades, is increasingly angry at society’s wealthiest members. It perceives much of their recent wealth to be ill-gotten, not resulting from true economic wealth creation [and they are correct], and seeks social justice through populist movements outside of the traditional left-right debate. The QE monetary disruption almost certainly contributed to the protest votes that have been observed in the Western world.

The central banks now bear a large responsibility. If they ignore the political impact of the measures they took, they will exacerbate a politically volatile situation. If, on the other hand, the gains made by the state from QE can be channeled to true economic wealth creation and redistribution, they will have saved the day.

This is entirely possible. Rather than debating how and how fast to end quantitative easing, the central bank assets generated by this program should be put into a huge fund for education and infrastructure. The interest earned on these assets could finance real public investment, like research, education and retraining. [That’s fine, but it does little to compensate for the massive transfer of existing wealth that is causing the political and social dislocations, such as unsustainable urban housing costs.]

If the proceeds of QE are invested in growth-expanding policies, the gain will help finance tomorrow’s retirements, and the government-induced asset inflation can be an investment, not simply a tax.

At Long Last, the Fed Faces Reality

The Fed faces reality? After 8 years, I’m not holding my breath…

Unconventional monetary policy—including years of ultralow interest rates—simply hasn’t delivered.

By GERALD P. O’DRISCOLL JR.

WSJ, Dec. 15, 2016 

As was widely anticipated, Federal Reserve officials voted Wednesday to raise short-term interest rates by a quarter percentage point—only the second increase since the 2008 financial crash. The central bank appears to have finally confronted reality: that its unconventional monetary policy, particularly ultralow rates, simply has not delivered the goods.

In a speech last week, the president of the New York Fed, William Dudley, brought up “the limitations of monetary policy.” He suggested a greater reliance on “automatic fiscal stabilizers” that would “take some pressure off of the Federal Reserve.” His proposals—such as extending unemployment benefits and cutting the payroll tax—were conventionally Keynesian.

Speaking two weeks earlier at the Council on Foreign Relations, Fed Vice Chairman Stanley Fischer touted the power of fiscal policy to enhance productivity and speed economic growth. He called for “improved public infrastructure, better education, more encouragement for private investment, and more effective regulation.” The speech, delivered shortly after the election, almost channeled Donald Trump.

Indeed, the markets seem to be expecting a bigger, bolder version of Mr. Fischer’s suggestions from the Trump administration.

• Infrastructure: Mr. Trump campaigned on $1 trillion in new infrastructure, though the details are not fully worked out. The left thinks green-energy projects—such as windmill farms—qualify as infrastructure. Living in the West, I’d prefer to build the proposed Interstate 11, a direct line from Phoenix, to Las Vegas and then to Reno and beyond.

• Education: Nominating Betsy DeVos to lead the Education Department shows Mr. Trump’s commitment to real education reform, including expanded school choice. Much of America’s economic malaise, including income inequality and slow growth, can be laid at the feet of deficient schools. Although some students receive a world-class education, many get mediocrity or worse.

• Private investment and deregulation: Mr. Trump promises progress on both fronts. He is filling his cabinet with people—including Andy Puzder for labor secretary and Scott Pruitt to lead the Environmental Protection Agency—who understand the burden that Washington places on job creators.

Businesses need greater regulatory certainty, and reasonable statutory time limits should be placed on environmental reviews and permit applications. That, along with tax cuts, would do the trick for boosting investment.

All that said, central bankers have a role to play as well. The Fed’s ultralow interest rates were intended to be stimulative, but they also squeezed lending margins, which further dampened banks’ willingness to loan money.

There’s a strong case for a return to normal monetary policy. The prospects for economic growth are brighter than they have been in some time, and that is good. The inflation rate may tick upward, which is not good. Both factors argue for lifting short-term interest rates to at least equal the expected rate of inflation. Depending on one’s inflation forecast, that suggests moving toward a fed-funds rate in the range of 2% to 3%.

The Fed need not act abruptly, but it also does not want to get further behind the curve. Next year there will be eight meetings of the Federal Open Market Committee. A quarter-point increase at every other meeting, at least, would be in order.

This could produce some blowback from Congress and the White House. Paying higher interest on bank reserves will reduce the surplus that the Fed returns to the Treasury—thus increasing the deficit. But the Fed could ease the political pressure if it stopped resisting Republican lawmakers’ effort to introduce a monetary rule, which would curb the central bank’s discretion and make its policy more predictable. This isn’t an attack on the central bank’s independence, as Fed Chair Janet Yellen has wildly argued, but an exercise of Congress’s powers under the Constitution.

The one big cloud that darkens this optimistic forecast is Mr. Trump’s antitrade stance. Sparking a trade war could undo all the potential benefits that his policies bring. David Malpass, a Trump adviser and regular contributor to these pages, argues that trade deals like the North American Free Trade Agreement are rife with special benefits for big companies, but that they do not work for America’s small businesses. The argument is that Mr. Trump wants to renegotiate these deals to make them work better. I hope Mr. Malpass is correct, and that President-elect Trump can pull it off.

But for now, a strengthening economy offers a chance to return to normal monetary policy. Fed officials seem to have come around to that view. With any luck, Wednesday’s rate increase will be only the first step in that direction.