George Magnus, the UBS economist who popularized the concept of a Minsky Moment and has been prescient in his bearish calls on the credit markets, veered today and, in a Financial Times comment, “More is needed to unblock credit arteries,” gave unqualified support for aggressive monetary easing.
Put it another way, when mere New York Times reporters, in today’s piece, “A Fear That the Cure Could Be Poison,” sound a reasonable cautionary note absent from Magnus’ piece, namely that too much stimulus could create a new financial mess down the road (their culprit was inflation), something is wrong. And the ECB is still plenty worried about inflation, even if Magnus dismisses it.
Of course, it may simply be that Magnus is better at forecasting than policy. And it is also fair to say that there is no good playbook for the mess we are in.
As an aside, I believe that, as the Times suggests, attempts to forestall the inevitable may well make things worse. Our economy has become completely dependent on credit form overseas. Today’s Bloomberg shows that China still reports robust growth despite the falloff in the US. That on the one hand suggests problems in the US may slow but not tank global growth, but also may suggest that China is not as deeply hostage to our continued growth as many would like to believe.
Put it more bluntly: too much easing will tank the dollar. Brad Setser has said that while the current account surplus has fallen. so too have foreign private inflows. We are living on the largesse of foreign central banks. Remember, the oil embargo of the 1970s started because we made the mistake of calling Saudi Arabia’s bluff when they told us to get Israel to withdraw from the lands occupied in the 1967 war, and give access to some sites important to Muslims. What if they decide again to push us over Israel? The states with the liquidity are not democracies, they are not accountable to voters and are willing to take losses (say on Treasury holdings) if they perceive there to be long-term gain. This set of circumstances will give not-necessarily friendly economic partners even greater sway over us.
Here is the part of Magnus’ piece where he manages to hoist himself on his own petard:
The Federal Reserve’s surprise emergency cut in interest rates on January 22 may be followed quickly by another reduction at the formal meeting on January 30 and almost certainly presages easing by European central banks. We should banish all talk about whether these initiatives are inflationary or not. It is not for nothing that we call a banking crisis a “deflationary credit event”. What the Fed is trying to do is to head off the worst aspects of a banking crisis in which the arteries of credit that drive economic activity are becoming blocked.
The feast-to-famine turnround in the willingness to lend and the terms of lending, while rare, is not unprecedented. It happened after the US savings and loan crisis in the 1980s, in the commercial property fall-out and Scandinavian and Japanese banking crises in the early 1990s, and after the dotcom bust in 2001. The most recent feast can be appreciated by looking at the credit intensity of gross domestic product, or the amount of credit generated per $1 of GDP growth. This remained at about $1.50 for decades after 1950, eventually rising in the 1980s and peaking at $3 during the 1990s. The credit machine went into top gear again and by 2007, nearly $4.50 of credit was being generated per $1 of GDP growth.
While there is no methodology for determining the optimal debt to GDP ratio, the increase from the 1980s and particularly in the current decade is alarming and all the signals are that it is not sustainable. Mortgage defaults, rising credit card delinquencies, and the expected rise in commercial real estate and corporate bad debt, in combination with our non-existent saving rate, all confirm that the economy is carrying far more borrowings than it can support. Yet Magnus thinks the answer is to “unblock the credit arteries” and give more of the same! It’s tantamount to prescribing a quadruple bypass, then sending the patient home with no post-op lifestyle changes, not even a supply of Lipitor.
Like it or not, America is going to have to consume less and save more. That means a slowdown, likely a recession. Any other remedy piles on more debt and risks even greater credit losses and institutional carnage down the road, as well as the greater possibility of disruptive changes in our lifeline of credit from abroad.