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

  1. I can believe there are incremental policies developed that chip away at the inequality whilst not letting it all burn. The combination of below may dampen the worst effects:

    Universal Income
    Lower cost education
    Small wealth tax
    Larger inheritance tax

  2. Taxes need to be more progressive both at the corporate and individual level. And we need to rebuild and adjust the safety net for our citizens so that when economic tornadoes blow through the economy the answer is not a nationalistic antiglobal wave that kills innovation, trade and growth. In real terms that means universal health care, increased aid to education, and a much higher minimum wage. The economy also badly needs investment in public goods capital stock, like roads, bridges, hospitals, schools etc. What a wonderful opportunity with low interest rates to finance it! It also makes sense to institute a slightly progressive version of a VAT to finance many of these efforts and to backstop medicare, medicaid and social security. In that way, everybody pays.

  3. Thank you! I know you keep hammering on this and it’s largely preaching to the choir here, but I want to scream this article from the rooftops. Unfortunately, understanding this analysis requires nuance and most people can’t or won’t engage with the facts you’ve laid out.

    My father-in-law has a masters degree in economics, works for a small bank, and follows the markets closely, but even he can’t seem to wrap his head around this and thinks he has gotten the short end of the stick on government stimulus even though he is likely among, or nearly so, the 1%.

    Given that, how do we turn this into a short slogan for the masses?

    1. Wealth of the Nation not the greedy individual.
      Getting rich off the fat of the land is fine, picking our bones clean, not fair.

  4. Thank you for this on-point essay. Also I’ve been meaning to read Skidelsky, who seems better at economics than the hard-core economists. Even if these ideas become accepted intellectually in private, it’s hard to envision a future in which the current political-economic dogmas give way to their full embrace. What is the probability that the same old same old septuagenarian Democrats, and their key advisors like Larry Summers, will repudiate their life’s work of neoliberal, monetarist mistakes? What is the probability that the so-called fiscal conservatives in the GOP will acquiesce to MMT Trump or go full gaslight and underwrite a new New Deal that is essentially the opposite of their hard-money views? Looking around Europe, it’s also hard to find an obvious leader or anything close to an EU-wide consensus for any of this. The cynical view is that the monetarists have been so effective at “state capture”, that their corruption will never allow it to happen so long as their asset prices keep rising.

  5. This article hits on many hot points for me

    Even a fiduciary cannot handle my money as well as I may. Buybacks create a hazard. Uninvested earnings should pass through a shareholder’s hands. Change the tax code!

    UBI seems predestined. A poorly designed tax code may cause people to stay unemployed. A properly graduated tax may appear to penalize the middle class but only because the 1% are hiding behind them

    Finally, i may need to take on more interest rate risk and reduce credit risk

  6. Income producing real estate is taxed on at least three levels and sometimes on four levels:
    1. annual valuation tax (i.e. property taxes)
    2. income tax (after deduction of debt interest and appreciation – although some ownership entities, such as pension funds, are income tax exempt)
    3. transfer tax when sold
    4. sometimes: tax on gross revenue (eg. in the City of San Francisco)

    Other assets (non-real estate) should also be taxed on valuation and on sale (albeit at the federal level vs the local level). A valuation tax would create pressure to pay dividends (generally also taxable) vs. fund share buybacks. A transfer tax would encourage long-term investing vs. short-term investing. All this would take a little bite out of the financial asset inflation that is “concentrated disproportionately in the hands of the wealthy” and immediately narrow the (paper) wealth gap.

    1. I am not a proponent of transfer taxes for financial assets, nor real estate. Transfer taxes on real estate are relatively rare, thank goodness. However the remainder are points well received. Why do counties not tax financial asset holdings (valuation) for residents? At least on the surface it would seem an asset is an asset no matter how it is held. It would seem if the asset has real property component such as a refinery then a tax exclusion for the holder would be required as they already paid property taxes on the hard assets.

      1. I imagine that taxation of financial assets would need to happen at the federal level, as financial assets are mobile (while real estate obviously is not). Of course, financial assets can be moved offshore but the federal gov’t is better able (than local gov’t) to deal with this form of potential evasion.

  7. Presumably we are all believers in the awesome power of policymakers to deliver outcomes that eliminate the hard reset that the “libertarian” or Austrian types are calling for. The problem might be whether there ever comes a time when the system is so unbalanced, so fragile that policymakers cannot stabilize it. We are in genuflect mode to the Fed in 2020. Is it possible that market forces one day will force a reset in which policymakers are unable to moderate? I imagine an inflationary bust would be one possibility of that.

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