There are three problems with our current situation, one of
which is relatively straight forward to address. Of the remaining two problems, one is much
bigger, and the other much longer-term.
The easy one would be to roll back the lion’s share of Dodd-Frank:
a knee-jerk reaction by a bunch of goofballs who neither understand
money, nor have ever met a regulatory opportunity they didn’t like. The financial chaos they have unleashed in
their 2,300 page bill is abhorrent. As
of the end of 2011—18 months after the bill’s passage—75% of the deadlines related to 400 rule-making requirements had not been met. To listen to CEOs of major money-center banks
say in the year 2012 that they’re not sure how to plan for Dodd-Frank because they
don’t know what the rules will be is simply stunning. The degree to which this one law has
amplified strategic uncertainty for financial institutions almost cannot be
overstated.
The big problem is that even after the Fed nearly tripled the
size of its balance sheet, and despite Congress’ massive stimulus bill, we’ve
learned that our government's power to impact our macroeconomic situation is asymmetrical. In
other words, between the Fed, the White House, and Capitol Hill, our leaders have been
able to temporarily avert disaster, but they have very little ability to actually
engender economic growth.
It might help to picture John Maynard Keynes with only one leg: sure, he can stand up, but he can't really move anywhere.
To tackle this problem, we're going to have to drop this childish fantasy that government bureaucrats actually grow anything in the economy. Our government exists and runs only because the private sector (individuals and businesses) funds it through taxes. There are no ultra-smart Wizard of Oz guys in Washington, making the whole thing work magically. There are a bunch of little old men behind the curtain who think the levers they're pulling are doing important things, but again, their contribution is at best asymmetrical.
A pro-growth policy asks "How can we incentivize the private sector to grow the economy, so that the government can collect just enough money to meet its obligations?" You can read more about the relationship between taxes and economic growth here.
The long-term problem looks like this: in a fractional reserve system, what happens if banks should quickly turn most of the $1.5 trillion of reserves into loans? The money supply would explode, and as Friedman reminds us, that means inflation. Like, you know, a LOT of inflation. The fear of inflation is a main reason why gold is in such a massive bubble right now.
A pro-growth policy asks "How can we incentivize the private sector to grow the economy, so that the government can collect just enough money to meet its obligations?" You can read more about the relationship between taxes and economic growth here.
The long-term problem looks like this: in a fractional reserve system, what happens if banks should quickly turn most of the $1.5 trillion of reserves into loans? The money supply would explode, and as Friedman reminds us, that means inflation. Like, you know, a LOT of inflation. The fear of inflation is a main reason why gold is in such a massive bubble right now.
By the way, if you’re invested in gold, what’s fair value
for 1 ounce? You can get back to me on
that one.
The Fed’s only surefire tool to hold all that potential
liquidity behind the dam and avert runaway inflation is to permanently
increase the level of required reserves.
That may sound easy enough, however reducing the percent of each dollar that can be lent will have a huge impact on the
speed of future economic recoveries. Unwinding this situation could take
decades.
All is not hopeless.
If we pursue pro-growth policies, we can mitigate these threats, and we
can do so more rapidly than you’re probably picturing. What this looks like is reducing massive,
choking regulation (e.g., Dodd-Frank) in favor of higher bank capital requirements
(a la Basel III).
It means that the Fed should quit paying interest on excess reserves immediately (and maybe even charge interest on them), which would encourage banks to lend more right now. Although, if banks don't lend, it's not necessarily just because they don't want too. It may be hard to believe, but there is mounting evidence that many businesses simply don't want to borrow in an environment of such regulatory uncertainty. But that is, as they say, 'a whole nother' topic, one I'll illustrate in a future blog post.
In tandem with ceasing to pay interest on excess reserves, the Fed should announce a temporarily higher reserve requirement, accompanied by a schedule to reduce the required reserve ratio to normalized levels over a few years. John Taylor's recent article summarizes well the argument for a rules-based monetary policy.
I have two framed displays on the wall of my office, one right above the other. The top one holds a gold-backed Chinese government bond from 1913 on which the republican government defaulted when the Japanese invaded Manchuria. When the communists took over, they repudiated this issue and several other bonds as "the debt of an illegal regime." So far, the Chinese are the only G-10 country to repudiate portions of their own debt. The other frame holds four original German banknotes showing the runaway inflation of the 1920s: 100, 1,000, 1 million, and 1 billion mark notes. In August of 1922, it was still worthwhile for Germany to print 100 mark notes. By September of 1923, they were printing 1 billion mark notes.
As a global investor, I keep those displays there to remind me of the two options governments have when they get into deep trouble: inflate the value of their debt away, or simply default on it. Greece just chose option B. The looming Medicare crisis on top of our $15 trillion worth of federal debt (growing at the rate of over $1 trillion per year) potentially lead to our very own Chinese bond situation. $1.6 trillion of accessible excess reserves potentially leads to our very own German mark situation. I wish I were making this stuff up, but I'm not.
We can still avoid both default and runaway inflation, but we have to act quickly, and smartly. Do we have the will to do so?
It means that the Fed should quit paying interest on excess reserves immediately (and maybe even charge interest on them), which would encourage banks to lend more right now. Although, if banks don't lend, it's not necessarily just because they don't want too. It may be hard to believe, but there is mounting evidence that many businesses simply don't want to borrow in an environment of such regulatory uncertainty. But that is, as they say, 'a whole nother' topic, one I'll illustrate in a future blog post.
In tandem with ceasing to pay interest on excess reserves, the Fed should announce a temporarily higher reserve requirement, accompanied by a schedule to reduce the required reserve ratio to normalized levels over a few years. John Taylor's recent article summarizes well the argument for a rules-based monetary policy.
I have two framed displays on the wall of my office, one right above the other. The top one holds a gold-backed Chinese government bond from 1913 on which the republican government defaulted when the Japanese invaded Manchuria. When the communists took over, they repudiated this issue and several other bonds as "the debt of an illegal regime." So far, the Chinese are the only G-10 country to repudiate portions of their own debt. The other frame holds four original German banknotes showing the runaway inflation of the 1920s: 100, 1,000, 1 million, and 1 billion mark notes. In August of 1922, it was still worthwhile for Germany to print 100 mark notes. By September of 1923, they were printing 1 billion mark notes.
As a global investor, I keep those displays there to remind me of the two options governments have when they get into deep trouble: inflate the value of their debt away, or simply default on it. Greece just chose option B. The looming Medicare crisis on top of our $15 trillion worth of federal debt (growing at the rate of over $1 trillion per year) potentially lead to our very own Chinese bond situation. $1.6 trillion of accessible excess reserves potentially leads to our very own German mark situation. I wish I were making this stuff up, but I'm not.
We can still avoid both default and runaway inflation, but we have to act quickly, and smartly. Do we have the will to do so?
No comments:
Post a Comment