The Bear’s Lair: Funny money makes us unproductive

William Holman Hunt's The Awakening Conscience

The central banker, after too much stimulus, realizes her error


Two weeks ago, this column denounced central banks’ post-2008 policies because of their effect on savers and savings. This week I will demonstrate an entirely different result of their feckless policies: a deep decline in productivity growth, in all markets where their foolishness has manifested itself. There is not enough criticism of this insanity, even from the allegedly free-market media. With the two effects outlined, there can however be no question that it is impoverishing us all, to a greater extent each year.

To begin with the factual evidence: Productivity growth in the United States was 2.9% per annum in 1948-73; it declined to 1.9% per annum in 1973 to 2010, but has plunged much further to a mere 0.4% per annum since 2010. The post-1973 decline was almost certainly due to the advent of excessive meddling regulation. The post-2010 decline could be partly due to even more aggressive regulation on the part of the no-business-left-un-harassed Obama administration, but it could also be due to funny money. The evidence from other countries, where regulation has not significantly intensified in recent years, suggests that the primary cause is funny money, although the U.S. position, with money slightly less funny and regulation intensified, suggests that a dual explanation may be the most accurate in this market.

Outside the United States, productivity growth in Britain averaged 2.2% annually from 1959 to the fourth quarter of 2007, but has since collapsed to a mere 0.1% annually, although the pattern is different from the U.S. one, with a mild recovery in the last couple of years rather than a further decline, possibly due to relaxing British regulation under the Cameron governments.

In the Eurozone, productivity growth has declined from 1.3% annually between 1995 and 2007 to 0.7% annually between 2007 and 2015. This is a less marked decline, to be sure, but still a substantial change. You also have to remember that until the last year or so the European Central Bank was more conservative in its pursuit of funny money policies than the Fed or the Bank of England, let alone the Bank of Japan. As for regulation, it’s horrible, but it always has been.

Finally, in Japan labor productivity held up very well after the 1990 crash, contrary to endless stories about Japan’s “malaise,” with manufacturing productivity in 1990-2008 rising at a brisk 2.6% annual rate, similar to that of the pre-regulation United States and faster than U.S. growth during this period. Since then however, as funny money policies have been pursued with ever increasing enthusiasm, manufacturing productivity has declined at a 1.7% annual rate, with the fall intensifying in the last two years of “Abenomics”, negative interest rates and record-breaking monetary stimulus.

Conversely, this productivity growth slowdown has not happened in emerging markets, where interest rates have been kept at more normal levels. According to the Conference Board’s Total Economy Database, productivity growth in major emerging economies (Brazil, Russia, India, China, South Africa, Mexico, Indonesia and Turkey), which averaged 4.9% annually in 1999-2006, was even slightly higher at 5.2% annually in 2007-15 (the last year being projected.) None of these economies have run zero interest rate policies; their overall monetary policy, while somewhat looser than has traditionally being the case (reasonably so, with global liquidity being so easily available) has held interest rates far above zero and in most cases higher than the inflation rate.

The facts are there. The correlation between truly extreme monetary policies and truly lousy productivity figures is unmistakable; if you have had the one, you are getting the other. The theory of Professor Robert Gordon, that our technological advances are becoming more and more trivial so productivity growth is declining long-term, doesn’t fit with the timescale – productivity growth would slow over decades, not all at once. However, correlation is not causation, and those of us who believe the two to be connected need to suggest an economic mechanism by which ultra-low interest rates, negative in real terms, might cause unexpectedly poor productivity growth.

There are two possible mechanisms I can think of, though a better economist might be able to think of others. One is through savings, as I discussed two weeks ago. Savings pools are an essential ingredient in the formation of new businesses (venture capital is responsible for a tiny fraction of the total.) However, the rate of new business formation has declined from 12.0% of all establishments to 10.2% from 2007 to 2013, although admittedly this is simply a continuation of a long-standing decline from a rate of 17.1% in 1977. The fact that the decline dates back to the 1970s suggests that much of it may be due to regulation, but its continuation since 2008 certainly indicates problems in the savings/capital formation/entrepreneurship chain.

The other possibility derives from Austrian economic theory, which looks at investment. The productivity of investment is optimized when interest rates are at their “natural” rate taking account of the development level of the economy, the state of the business cycle, etc. At this rate, which equates to the “gold standard” rate in periods when the gold supply has neither been artificially boosted by massive new discoveries nor suppressed by past payments imbalances as in the 1920s, the price of capital is in equilibrium with that of labor and other factors of production, and hence investment quality is maximized and the economy’s productivity optimized.

It is a staggering commentary on the ineptitude of our central bankers that they are unable to keep interest rates at or about this natural rate, which generally equates to 2-3% above the rate of inflation, but may be higher or lower in special circumstances.

Instead, central bankers have pursued a Keynesian political fad and held interest rates for eight years far below their natural level. In the United States currently, for example, with “headline” inflation about 1% and “core” inflation above 2%, and unemployment close to 5% reflecting an economy near the peak of the cycle, it is inconceivable that the “natural” rate of interest is close to the Fed’s current target of 0.25-0.5%, its current target. Negative real interest rates are by definition unnatural, because they make money in the future worth more than money now.

While the “natural” U.S. interest rate may not be quite 4% at present, because of the lagging effects of the oil price decline tending to suppress inflation, it is certainly at least 3%. A competent Fed, not in any way seduced by the charms of a gold standard but simply trying to keep monetary policy on an even keel, would see this. We do not however have such a Fed, and nor do Britain, the EU, or Japan; we have a Fed seduced by Keynesian nonsense into believing that its off-kilter interest rates are in some way “stimulative.”

With interest rates so far from their natural level, money pours into wasteful projects, real estate investments such as the grossly overbuilt hotel industry and other boondoggles. Companies do not engage in productive investment, finding it more easily profitable to repurchase their stock and boost options profits thereby. Wall Street undertakes a morass of junk bonds and merger deals, while utterly worthless corporate empires such as Valeant (NYSE:VRX) are constructed based on business strategies that haven’t a hope of working in the long run.

When interest rates are so far from equilibrium, since bad investment offers higher and quicker short-term profits than good investment, more bad investment is carried out. The result is that the economy moves further and further from an optimal state, destroying productivity as it does so. After eight years, the economy’s state is pathological; only a massive downturn and destruction of the bad investment will cleanse out the system and allow productivity to begin growing again.

Of all the misallocation of resources that is taking place, the worst is towards the gigantic budget deficits that remain in place in almost all the world’s major economies. By definition, since the deficits divert resources to the politically-allocated sector rather than the market-allocated sector, they represent a massive diversification of resources into inefficiency, in many cases accompanied by corruption.

$500 billion per year (considerably more if the accounting is done properly) is being sucked out of the U.S. economy every year to finance the Federal budget deficit, which even close to the top of the economic cycle is growing not shrinking. Similarly, Britain’s attempt at “austerity” has been feeble by comparison with Margaret Thatcher’s 1980s and still does not have the budget close to balance. France, Italy and many other EU countries are making up for Germany’s prudent fiscal management by continuing to run large budget deficits, running up their public debt year by year. The effect is made worse by central bank asset purchases, which artificially inflate the money supply to no good end, while further distorting the capital markets.

Overall, the fiscal problem is most severe in Japan, where the state deficit sucks in 6% or more of GDP and has done so every year since 1990, while idiot politicians propose yet more futile “stimulus” programs that make the state deficit even bigger. Of course, the Japanese economy is now highly inefficient; how could it be otherwise, when the government debt pool is over 250% of GDP? Productivity in Japan has stopped growing altogether and has started to shrink at ever-increasing rates. There now appears no way out of a vortex of impoverishment leading to a state bankruptcy.

Former Fed chairman Alan Greenspan identified the productivity problem in a broadcast roundtable last week, but lacked the cojones to pin the blame squarely on his successors. Larry Fink of Blackrock also appears to have identified the savings problem, though he has yet to connect the productivity deficit to the question. Worldwide, this will no longer do. Like the central figure in Holman Hunt’s “The awakening conscience” the world’s central bankers must quickly come to a realization of the appalling damage their monetary foolishness has created, and move to rectify their behavior forthwith.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)