‘You Can’t Get Fooled Again’: Is America Ready For Real Economic Solutions Or Not?

“Yes, US policy is one step improved from the post-2009 bank-centric errors, but it is still a long way from being a framework that one could say with confidence will lead to a real, sustainable recovery”, Rabobank’s Michael Every writes, in a new note which strikes at the heart of something I’ve struggled to communicate over the course of the current crisis.

The investing public seems to realize that, acting on its own, extraordinarily accommodative monetary policy invariably leads to asset price inflation, and that asset price inflation exacerbates inequality.

That’s pretty straightforward. Financial assets are concentrated disproportionately in the hands of the wealthy. When those assets appreciate, the benefits accrue exponentially. Over time, that leads to higher levels of concentration.

A smaller set of investors understands this on a more nuanced level — they grasp a deeper “why”, as it were.

This is very often left out (purposefully in some cases) of commentary criticizing the Fed. It’s not that the “wealth effect” doesn’t work. When you drive up the prices of financial assets, some of the benefits do accrue to middle-class families (they own some stocks, after all), and some of the windfall from rock-bottom borrowing costs for corporations does eventually find its way into investments in labor, R&D and productive capacity.

The problem (and this is the critical nuance), is that the transmission mechanism through which monetary largesse acts on financial asset prices is orders of magnitude more efficient than the channels through which those same policies act on the real economy.

Corporates, meanwhile, are clearly incentivized to act in a way that bolsters their bottom lines, enriching executives and shareholders in the process. With apologies, that’s American-style capitalism.

What you end up with is not so much an inherently nefarious, conspiratorial dynamic, as much as it is a self-feeding loop turbocharged by greed. Those are not the same thing. Rigging Libor is a conspiracy. Tapping the bond market when the cost of debt is lower than the cost of equity and using the proceeds to buy back shares, is just taking advantage of the opportunity staring you in the face. Is it the “right” thing to do? Not always. Not usually, even. But capitalism isn’t exactly a system that adheres strictly to normative concerns.

Where this conversation breaks down (in most cases entirely) is when one endeavors to explain how this dynamic can be reformed.

The “solution” offered by too many ostensibly “smart” commentators is simply for central banks to stop enabling this perpetual motion machine of inequality creation.

Many of those same commentators will readily admit that doing so chances disaster — that raising rates, ceasing to inject liquidity through asset purchases, and otherwise tightening policy, would very likely plunge the entire system into crisis, as an over-leveraged corporate sector is suddenly exposed to the harsh realities of price discovery.

Of course, that would be painful. And not just for corporations and shareholders. Rich people can, by definition, afford to lose a lot more than the poor. I often quote Robert Skidelsky on this point.

“On the Austrian analysis, recessions give a chance to re-allocate ‘mal-invested’ productive factors to efficient uses [and] they should therefore be allowed to run unhindered until they have done their work”, Skidelsky writes, in Money and Government, before reminding readers that “economists whose common sense had not been completely destroyed by their theories rejected the drastic cure of destroying the existing economy in order to rebuild it in the correct proportions”.

As Skidelsky alludes to, the idea of letting it all burn to the ground in order to ensure that every, last bit of misallocated capital is purged is, at best, implausible. At worst, it’s madness.

Seen in that context, it makes sense that the Fed and Congress have joined forces to assist corporate America in the current crisis, even as, in many cases, corporate America does not “deserve” such assistance.

What’s going on now is different from what happened post-financial crisis.

“The stimulus is aimed at getting liquidity to firms via central-banks and/or governments back-stopping low-cost loans”, Rabobank’s Every writes, in the same note cited here at the outset. “This is an improvement over giving the money to banks and watching them continuously refuse to lend it”, he continues, referencing what happened after 2008/2009, when “liquidity injections to banks guided asset prices significantly higher but did not flow to the real economy”.

Eventually, banks did lend, and corporate management teams did borrow, but, as noted above, this activity was not designed to facilitate the kind of economic outcomes that benefit real people. Instead, it was aimed at M&A and financial engineering (i.e., issuing debt to fund buybacks).

“Corporate loans gradually recovered, corporate debt gradually recovered too, mortgage lending only started to pick up after 2015, and yet private gross fixed capital formation saw only a very moderate increase”, Every writes.

(Rabobank)

Part of the problem post-financial crisis is that fiscal policy simply ceased to be of much help. Central banks were left on their own to shoulder the burden of the recovery, while politicians embarked on misguided, quixotic austerity missions, tilting at deficit windmills with the effect of offsetting monetary accommodation.

As alluded to above, we have seemingly learned a little something from that experience. Stimulus in the wake of the COVID panic has taken the form of loans to businesses (and grants to small businesses) and programs aimed directly at ensuring corporations retain access to financing.

At the same time, monetary policy is openly enabling fiscal spending, and thereby funding direct payments to households, enhanced unemployment benefits and, hopefully, an infrastructure bill in the US.

Rather than being welcomed, both of these improvements have been castigated, for different reasons.

Loans to medium- and large-sized corporations “don’t help Main Street”, we’re told, and the buying of corporate bonds by the Fed is replete with moral hazard, blunts price signals, and may be illegal, according to all manner of critics, most of whom are not lawyers.

Meanwhile, direct assistance to households is likened by critics to “handouts”, which disincentive work. And the prospect of simply mainlining money into the veins of Main Street via the direct, overt monetization of fiscal initiatives (i.e., Modern Monetary Theory, or, “MMT”), is branded “radical”, and potentially “ruinous” over the longer-term.

This is why I often say that the conversation breaks down at the most critical juncture.

Everyone seems to agree that monetary policy acting on its own, without coordinated fiscal stimulus, serves to inflate asset bubbles and increase inequality. And everyone seems to at least intuitively understand that a big part of the problem lies in the transmission mechanism from monetary stimulus to the real economy.

And yet, the only solution that seems acceptable to critics is one that leans on the patently absurd notion that developed economies are prepared to suffer through an epic, romanticized “reset”, which entails letting it all burn, either figuratively or, depending on who you listen to, literally.

In reality, the vast majority of the public is not prepared to suffer through that, and many of those who promote it as a “solution” in fact live high on the hog, residing in expensive neighborhoods in some of America’s most exclusive zip codes, which makes their libertarian agenda and promotion of Austrian “remedies” not only hypocritical, but comically disingenuous.

The real solution is staring us right in the face and, indeed, we’re already implementing it. The Dallas Fed’s Robert Kaplan admitted as much earlier this month. “Because of the crisis we have actually taken a number of steps which are heading into new territory and so we’ve done some version of MMT, to some extent, to deal with this crisis”, he said.

He doesn’t seem particularly enamored with that, and neither do a lot of economists, running the gamut from “armchair” to Nobel laureate.

But, at some point, if we’re going to actually sever the loop that is so readily and universally maligned, we need to acknowledge and embrace the solutions on offer. That we won’t do so is made all the more ridiculous and inexcusable by the fact that we’re creating the money anyway and, as of the COVID crisis, implementing soft-MMT right out in the open.

As to the nexus between corporate assistance and Main Street, we again need to acknowledge that the current set of facilities established by the Fed is preferable to simply pumping vast sums of liquidity into bank coffers and assuming it will get where it needs to go, whether that’s to businesses or Main Street.

But, as Rabobank’s Every writes, we’d be naive to think that direct corporate assistance is sufficient to bring about the kind of robust recovery everyone wants to see. Here is an expanded version of the shorter quote I used above from Every:

The stimulus is aimed at getting liquidity to firms via central-banks and/or governments back-stopping low-cost loans. This is an improvement over giving the money to banks and watching them continuously refuse to lend itYet with even greater global uncertainty now than back in 2009, it is unclear if businesses will use new liquidity to do anything productive. We already see examples of major firms taking state bailouts – and then downsizing and/or again looking to purchase competition rather than investing for the future. Is this irrational? Would you expand your business in the present climate, with all of the risks to the downside? Would you hire new workers now? Or would you downsize? If funds are freely available, would you not use them for safer M&A? It is extremely optimistic to assume the surge in US corporate loans and bond issuance in Figure 8 is anything other than a desperate scramble for working capital; it is surely not heralding a surge in business capital formation in H2 2020 and 2021.

What’s nice about that quote is that it recognizes the improvement from the post-financial crisis model, but it also lays out all of the problems, and, crucially, couches them in real-world terms, as opposed to terms that suggest something is at play other than simple, corporate self-preservation.

So, what’s needed? Every drops a hint.

Even though liquidity “is now going to firms and not banks, as post-2009… with even greater global uncertainty, will firms use it to do anything productive?”, he goes on to ask. “If not, then even more action is still needed on the fiscal front: MMT anyone?”

Referencing the possibility that society will fail to understand all of this on the way to pulling back on fiscal stimulus even as monetary policy is ready and willing to enable it, Every cites a famous quote from a US president known for public speaking gaffes  — and no, I’m not talking about the current occupant of the Oval Office.

“There’s an old saying in Tennessee – I know it’s in Texas, probably in Tennessee – that says, fool me once, shame on – shame on you. Fool me – you can’t get fooled again.”

George W. Bush

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