Once upon a time economic analysis was “relatively” straightforward…growing, slowing, boom, recession…all part of an upward cycle…even if you got it wrong, it never really mattered…most problems appeared consequences of excess growth…
Something changed some time way back and we have been edging in spurts, lunges and various headlong gallops to yet higher precipitous vantage points…the valleys along the way have also yielded some many interesting experiences….whether this change was a structural process that started some way back in the 1980s (secular stagnation and there are indications this could be the case), or the consequence of a misplaced emphasis on maintaining the stability of the business cycle in the late 1990s (LTCM, Asian Crisis..again consequences of this are clear), that saw central banks lowering interests rates to maintain the growth cycle, or the increasing levels of consumption and debt and widening wealth and income inequality that came hand in hand with lower interest rates and more “stable” and longer growth cycles and or financial deregulation, is a part of the overall complexity of the matter.
One thing is clear to me: we have accumulated a very complex layered problem that is probably reflective of a significant deterioration of the fundamental structures underpinning stable growth, all the while bound up in an insanely wide variety of excess. The financial world, the world of assets (debt/equity) and asset prices, appears separated from the real world
The 1930s downturn could well be a simpler play/a forerunner of current more complex evolved dynamics..in other words periods of excess precede periods of decline (economic and asset realities crossing paths) and this decline in the end may have little or nothing to do with monetary policy mistakes in the period just preceding the bust or just following the bust…the fall had already been set…yes, monetary policy was likely too tight in both the 1930s and the late noughties, but only because of the vast debt and asset artifice built up around the economic infrastructure for one complex reason or another…it was the edifice that was too blame, not the monetary fault lines that cracked as a consequence of prior monetary excess….
Now we have a set of widening complex divergences:“secular stagnation”; debt overhangs; “deflation”; QE; “asset price bubbles”; excess asset focussed money supply growth; shadow banking fragilities and interconnectedness; demographic declines; weak income growth; growing inequality; vast global and domestic structural imbalances; vast debt financed over investment and excess savings in some economies; under investment and excess debt in others with debt financed share buybacks; over consumption/under consumption; Europe and its fixed exchange rate and hard monetary regime; zero lower bounds; supposed “liquidity traps” and god knows what else; all this centred around a financial system exposed to the fragility between asset values, GDP growth and debt.
One thing appears clear: the trend of the divide between asset accumulation and asset prices on the one hand and income growth, capital investment, wealth inequality and economic growth is a widening one in the QE zone and has been widening for some time. Despite the long term weakening of fundamentals, we have seen an increasing dependence on consumption in many a developed economy, consumption growth that had become increasingly debt financed, at least up to 2007.
GDP in one measure is all about consumption, whether it be consumption of today’s production or the purchase and partial consumption of goods used to produce future consumption…demand drives output and for a while, in an increasingly money supply asset focussed world, debt and asset values had helped sustain this consumption preference (note home equity lines of credit in the lead up to 2008 in the US)…
At the heart of the problem we have a lack of demand (or more aptly an imbalance behind the financing of demand): that is demand for consumption and investment goods is below the level needed to be able to support existing asset/debt values and to drive capital and human investment; but we also have an excess of consumption relative to other components of GDP, demographics and capacity (hence weak income growth and capital investment trends) given global structural imbalances….even with places like China where it is perceived we have insufficient demand and no structural excess of consumption, in terms of GDP components, this perception may only have relevance within the context of excessive short term over investment….
“Not enough and too much demand” (especially in the developed QE zone) has placed downward pressure on nominal growth rates and interest rates, capital and human capital investment; additionally falling interest rates designed to offset weakening nominal GDO growth have also given rise to rising asset focussed money supply growth…in a divergent world we have seen a rise in asset prices and large increases in the money and debt that has financed the rise in those asset prices….
A good part of our problems lie in the divergence between over consumption in developed economies and over investment in developing….the implosion of the financial system amidst excess debt in the developed world saw an increasing focus on debt and over investment in the developing world post 2008….these developing economies were highly dependent on demand growth in the developed world..
QE in a sense is the demand/investment starved world’s attempted solution to insufficient demand within an asset focussed world, while hell for leather debt financed gross fixed capital investment funded expansion is the developing world’s attempted solution to demand’s failure to keep up with the return requirements of its own fast developing capital frame ..
In the former we have had an excess of consumption and an excess of debt financed consumption and insufficient growth in GDP and incomes to support this structure. In the latter the economic infrastructure exceeds the nascent consumption capability of the economy.
Both QE and debt financed gross fixed capital investment are attempting to solve the same problem…insufficient return to support asset prices and their debt underpinning…both are impacting asset markets and creating similar instabilities but via different routes….holding back on QE and further debt driven capital investment projects risks a collapse in asset prices, with the consequences of such a collapse on the global financial system.
Nascent consumer components of developing economies with vast debt financed gross fixed capital investment projects appears to be going hand in hand with high levels of saving in these economies. Much of this excess saving has been channelled back into debt and assets, and asset prices via the residential property investment and the shadow banking system…in this framework high savings rates may appear to give the illusion of sound residential property markets and consumer stability…but in fact the savings and the assets they are funnelled into are themselves dependent on a debt financed growth…assets and liquidity (via the shadow banks) are at risk.
If the world’s economies had been shocked out of a trend growth path in 2007-2009, then QE could be said to have been designed to stabilise it and shock it back to its former growth path. But this assumes that the enveloping and developing imbalances and excesses did not exist.
QE via its support of asset prices was meant to support the balance sheet channel for stimulating loan growth (Bernanke). It was also I assume intended to create a wealth effect via rising asset prices: either people would save less or consume more of their assets and in by doing so refocus asset focussed money supply towards consumption. It may also have been intended to stimulate shadow banking via the imperatives of excess deposits and low interest rates. The trouble is given the complexity of the problems, the success and or failure of QE, and especially the inflationary risks of vast increases in the quantity of money and many other transmission dynamics, are occluded.
From my reading of the many different takes of QE we have entered a metaphysical dialogue over the meaning of money, its impact, its transmission, its risks and over the application of further QE and debt expansion in the name of getting the world economy moving and back on track. Some have argued that QE would be inflationary (it likely would have been without consumer debt defaults, slow wage growth, income and wealth inequality and globally weak economic growth) but ignored the debt and other structural dynamics that thwarted its theoretical transmission. Some believe that QE would never create inflation and by virtue of this display an ignorance over the power of the quantity of money if the economic system is working properly. Others focus on flows or the stock of money supply all the while ignoring that a healthy economy creates its own asset focussed money flows. Many ignore the risks of replacing natural with synthetic flows. A host of others believe that QE has not increased money supply, or have extended the definition of money supply to include all assets of varying shades of liquidity profiles.
There is much confusion over the natural dynamics of QE, of the quantity of money, of the asset transmission mechanism and of the impact of highly complex problems on attempts by monetary policy to knock the global economy back into a stable trend growth path.
And some reading: