One of the good things about those of the Austrian persuasion is that they serve to protect the flanks of the merely skeptical like me.
I am not exactly keen Ambrose Evan-Pritchard’s prescription, which is greater monetary easing with more fiscal restraint. I put banking industry reform (of the root and branch sort) very high on the list, but the sort needed will never happen in the absence of another breakdown. So we patch the system with duct tape and see how long it holds together. Failing that, I have doubts of the efficacy of monetary measures.
But that aside, I do agree with his more general points, that the current policy mix is not a good one, and that too many people are making the dangerous and often self serving assumption that we are out of the woods.
The financial system it is still vulnerable to shocks. We have maybe a 20% odds of a disorderly fall in the dollar. I was at a McKinsey presentation earlier this week. McKinsey advised the Treasury on the stress tests and is now advising the Fed. Given those roles, the firm is going to play risks down. But even they peg the odds of the dollar hitting an air pocket and causing serious collateral damage at 10-20%., pretty certain to be a systemic event,. There are also serious problems with the Euro banks . I don’t have a good enough sense to put odds on it, but I would hazard at least 10% odds of a systemic event emanating from some nasty blowups.
Nearly 30% probability of serious bad stuff happening is NOT in any mainstream scenarios. Yes, odds favor us muddling through with very weak growth, but the downside is considerable, and is being ignored because taking the right measures will be bad for “confidence”
From the Telegraph (hat tip reader Don):
Events have already forced Premier Brian Cowen to carry out the harshest assault yet seen on the public services of a modern Western state. He has passed two emergency budgets to stop the deficit soaring to 15pc of GDP. They have not been enough. The expert An Bord Snip report said last week that Dublin must cut deeper, or risk a disastrous debt compound trap.
A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12pc and heading for 16pc next year.
Education must be cut 8pc. Scores of rural schools must close, and 6,900 teachers must go….Nobody is spared. Social welfare payments must be cut 5pc, child benefit by 20pc. The Garda (police), already smarting from a 7pc pay cut, may have to buy their own uniforms. Hospital visits could cost £107 a day, etc, etc….
No doubt Ireland has been the victim of a savagely tight monetary policy – given its specific needs. But the deeper truth is that Britain, Spain, France, Germany, Italy, the US, and Japan are in varying states of fiscal ruin, and those tipping into demographic decline (unlike young Ireland) have an underlying cancer that is even more deadly. The West cannot support its gold-plated state structures from an aging workforce and depleted tax base.
As the International Monetary Fund made clear last week, Britain is lucky that markets have not yet imposed a “penalty interest” on British Gilts, given the trajectory of UK national debt – now vaulting towards 100pc of GDP – and the scandalous refusal of this Government to map out any path back to solvency.
“The UK has been getting the benefit of the doubt, both in the Government bond market and also the foreign exchange market. This benefit of the doubt is not going to last forever,” said the Fund.
France and Italy have been less abject, but they began with higher borrowing needs. Italy’s debt is expected to reach the danger level of 120pc next year, according to leaked Treasury documents. France’s debt will near 90pc next year if President Nicolas Sarkozy goes ahead with his “Grand Emprunt”, a fiscal blitz masquerading as investment.
There was a case for an emergency boost last winter to cushion the blow as global industry crashed. That moment has passed. While I agree with Nomura’s Richard Koo that the US, Britain, and Europe risk a deflationary slump along the lines of Japan’s Lost Decade (two decades really), I am ever more wary of his calls for Keynesian spending a l’outrance.
Such policies have crippled Japan. A string of make-work stimulus plans – famously building bridges to nowhere in Hokkaido e_SEmD has ensured that the day of reckoning will be worse, when it comes. The IMF says Japan’s gross public debt will reach 240pc of GDP by 2014 e_SEmD beyond the point of recovery for a nation with a contracting workforce. Sooner or later, Japan’s bond market will blow up.
Error One was to permit a bubble in the 1980s. Error Two was to wait a decade before opting for monetary “shock and awe” through quantitative easing.
The US Federal Reserve has moved faster but already seems to think the job is done. “Quantitative tightening” has begun. Its balance sheet has contracted by almost $200bn (£122bn) from the peak. The M2 money supply has stagnated since January. The Fed is talking of “exit strategies”.
Is this a replay of mid-2008 when the Fed lost its nerve, bristling over criticism that it had cut rates too low (then 2pc)? Remember what happened. Fed hawks in Dallas, St Louis, and Atlanta talked of rate rises. That had consequences. Markets tightened in anticipation, and arguably triggered the collapse of Lehman Brothers, AIG, Fannie and Freddie that Autumn.
The Fed’s doctrine – New Keynesian Synthesis – has let it down time and again in this long saga, and there is scant evidence that Fed officials recognise the fact. As for the European Central Bank, it has let private loan growth contract this summer.
The imperative for the debt-bloated West is to cut spending systematically for year after year, off-setting the deflationary effect with monetary stimulus. This is the only mix that can save us.
My awful fear is that we will do exactly the opposite, incubating yet another crisis this autumn, to which we will respond with yet further spending. This is the road to ruin.