The standard way to finance these bailouts is to issue more government bonds. But it means that a private-sector debt crisis can morph into a public-sector debt crisis.
After 2008, that’s precisely what happened to Ireland and, to a lesser extent, Spain and Portugal.
Even in countries where the stricken banks eventually repaid most or all of their bailouts, such as the United States and the United Kingdom, the debt burden rose sharply as governments adopted stimulus programs to ameliorate the broader consequences of lending busts
. In the advanced economies as a whole between 2007 and 2014, Turner reports, public debt as a proportion of GDP rose by more than a third.
That’s a huge increase, so huge it has raised questions about the capacity of many governments to react to the next crisis.
Turner refers to this as the problem of “debt overhang”.
To break free from this ruinous debt cycle, Turner advocates strict limits on how much credit banks can issue.
In addition to forcing banks to hold more capital and thereby crimp their lending, he says, governments should regulate mortgage lending by imposing maximum loan-to-value ratios (for example, the size of your mortgage and the value of your house) and loan-to-income ratios. He also thinks that rising land values should be taxed more aggressively.
“Our explicit objective should be a less credit-intensive economy,” he writes. Given what we’ve been through in the past decade, that sounds like a good idea.
But what would provide the fuel for economic expansion? As Turner notes, “We seem to need credit to grow faster than GDP to keep economies growing at a reasonable rate.”
One option would be to step up the “quantitative easing” policies that the US Federal Reserve and the Bank of England have adopted in recent years.
Like Turner’s proposal, quantitative easing involves the central bank’s creating large sums of money, but rather than being handed out to people it is used to purchase large quantities of government bonds and other securities, with the goal of raising asset prices, driving down market interest rates, and stimulating spending. Unfortunately, as Turner points out, quantitative easing has “proved insufficient to deliver robust growth”.
Moreover, if it were maintained indefinitely, it could have harmful side effects. By keeping the cost of borrowing at ultra-low levels, and boosting the price of houses and other assets, it could end up triggering another credit boom. In parts of Britain, where house prices and mortgage issuances are now rising sharply, a credit boom may already be developing.
Turner cites an official forecast that in the United Kingdom over-all private-sector indebtedness “will by 2020 have risen to its highest ever level.” The implication is that another bust won’t be far behind.
The best alternative, Turner thinks, is his radical proposal of creating money and handing it out to entities that can spend it. He readily concedes that it wouldn’t matter much whether the newly minted money was forwarded to households in the form of bank credits, or used to finance tax cuts, or spent on building new roads and bridges.
The key point is that the government would be stimulating the economy without issuing any new debt.
It wouldn’t be accentuating the problem of debt overhang, or creating the conditions for yet another boom-and-bust cycle. Of course, creating money does pose other dangers, like an alarming jump in inflation.
Turner points to two instances where this didn’t happen. During the U.S. Civil War, the Union government printed greenbacks to pay for its military buildup without any disastrous consequences.
And in Japan, during the nineteen-thirties, the militarist government used the central bank to finance deficit spending and pull the country out of recession. But Turner acknowledges the counter examples like the hyperinflation experienced by the US Confederate states, Weimar Germany, and modern Zimbabwe.
To head off this danger, Turner says, money financing should be used sparingly, and for specific reasons: to pull an economy out of a lengthy slump, to pay for the recapitalization of too-big-to-fail banks, or to write off excessive public debts. “If we accept money finance as a normal operation, deployed continuously year after year, the danger that future governments will abuse it is greatly increased,” he notes.
Later in the book, however, he makes clear that he’ll entertain the possibility of creating money to finance ongoing budget deficits, as some adherents of Modern Monetary Theory recommend.
Referring to the warnings by Summers and others, he writes, “If the secular stagnation threat is truly as severe as some economists argue, we could counter it by using money finance not as a one-off device but continuously over time.” As a way of preventing elected politicians from overusing the electronic printing presses, Turner proposes putting money finance exclusively in the hands of independent central bankers.
Skeptics may wonder if this really solves the problem, though. Even independent central bankers aren’t immune to temptation, or to political pressures: many of them are political appointees, after all.
If a central bank adopted money finance for one purpose, such as avoiding a recession, and it proved successful, there would be enormous pressure to use it for others, such as debt reduction.
And the very hint of such a policy being enacted could sour the markets. Another weakness in Turner’s argument is his assumption that the standard remedy of a fiscal stimulus is no longer available. In the US and UK, budget deficits have fallen sharply in recent years, and, despite a rise in debt levels, interest rates are at historic lows, which indicates that the markets aren’t worried about those debt levels.
These countries should still have the room to adopt debt-financed stimulus packages. Even the Japanese government, which has huge debts, hasn’t had any trouble selling bonds to finance a big stimulus program introduced by Prime Minister Abe. Standard Keynesianism may be an endangered species, but it’s far from extinct.
And, since we know its pluses and minuses pretty well, it may be wise to stick to it where possible. Still, there are places — Greece and Ireland are obvious examples where Turner’s arguments carry force. Indeed, a strong argument can be made that the entire Eurozone could do with a dose of money finance.
Turner mentions a proposal for the European Central Bank to finance three-year tax cuts for all residents of the currency area, before noting that it’s probably not politically attainable. Less overt forms of money finance could be more palatable.
For example, the ECB could issue money to pay for infrastructure projects, carried out under the auspices of the European Investment Bank, which is owned by all the member states. Japan, whose public debts are equivalent to about two hundred and forty per cent of GDP, is another interesting case. After repeated rounds of quantitative easing, the Bank of Japan, the country’s central bank, now owns about a fifth of this debt. Like the Fed, it currently insists that it will eventually sell its bond portfolio back to private investors, and the Japanese Treasury Department says it intends to repay all its debts. But Turner points out another possibility.
Since one arm of the Japanese government is effectively lending to another arm, the public debt owned by the central bank could simply be written off. If that happened, Japan would have created a great deal of money and used it to reduce its debt burden, a form of money finance. And it’s hard to see how this would generate a spike in inflation. As this example indicates, some central banks are already exploiting their ability to create money in ways many of their citizens don’t fully understand.
So far, however, the monetary authorities have avoided explicitly financing spending by the private sector or the government and as a result, Turner argues, the US and other countries have incurred heavy costs. He writes: “Our refusal to use that option until now has depressed economic growth; led to unnecessarily severe fiscal austerity; and, by committing us to sustained very low interest rates, increased the risks of future financial instability.”
Whether you agree with Turner’s proposal or not, it represents an important challenge to economic orthodoxy, which, as he rightly notes, has already failed us once, (twice, if you include the Great Depression.) And on one point, at least, his argument can’t be challenged. Given the problems of debt overhang and slow growth, and the high toll that an extended period of economic stagnation could take on Western democracies, we face a choice of dangers.
We could revert to the standard model, hoping that another round of debt issuance in the public and private sectors will juice the economy. Or we could resort to something different and radical: the electronic printing press. To use the phrase Turner picked as his title, it is a choice between debt and the devil. If economic growth doesn’t pick up during the next few years, some countries may well decide to go with Old Nick. Stick with me and with The Standard for Part (3).
The currency markets
*** All quoted figures are as per 11th June, 2019 and are indicative only.
The commodity markets in the greater banjul areas
*** All quoted figures are as per 11th June, 2019
Entrepreneur quotes of the week
1. A nickel ain’t worth a dime anymore.
By Yogi Berra
2. Money never made a man happy yet, nor will it. The more a man has, the more he wants. Instead of filling a vacuum, it makes one.
By Benjamin Franklin
3. Many people take no care of their money till they come nearly to the end of it, and others do just the same with their time.
By Johann Wolfgang von Goethe
4. Money is only a tool. It will take you wherever you wish, but it will not replace you as the driver.
By Ayn Rand
5. Financial peace isn’t the acquisition of stuff. It’s learning to live on less than you make, so you can give money back and have money to invest. You can’t win until you do this.
By Dave Ramsey