Fallacies of Capitalism 14: Capitalism is Synonymous with Democracy

The "capitalism is synonymous with democracy" fallacy assumes a direct and harmonious relationship between capitalism, an economic system based on private ownership and market competition, and democracy, a political system characterised by representative government and citizen participation. However, this fallacy overlooks the potential conflicts that can arise between economic interests and democratic decision-making processes in several ways:

1. Power imbalances: Capitalism can lead to the concentration of economic power in the hands of a few wealthy individuals or corporations. These entities may exert disproportionate influence over political processes, such as lobbying or campaign financing, which can undermine the principles of equal representation and fair democratic decision-making. The resulting power imbalances can distort policy outcomes and compromise the interests of the broader population.

2. Influence of money in politics: Capitalist systems often allow for the infusion of large sums of money into political campaigns and lobbying efforts. This financial influence can create an uneven playing field, where economic elites can exert significant control over political agendas and policy outcomes. Democratic decision-making should ideally be based on the will of the people, but when economic interests heavily influence political processes, the voices and concerns of marginalised or less affluent citizens may be marginalised or ignored.

3. Regulatory capture: In capitalist systems, regulatory agencies are responsible for overseeing various sectors and industries to ensure fair competition and protect public interests. However, there is a risk of regulatory capture, whereby the regulated industries exert significant influence over the regulators. This can result in policies that favour the interests of powerful economic actors rather than promoting the broader welfare or democratic principles. Regulatory capture undermines the accountability and responsiveness of democratic institutions.

4. Inequality and political participation: Capitalism can exacerbate economic inequalities, which, in turn, can influence political participation. When wealth and income disparities are significant, certain groups may have greater resources and access to political power, while others may face barriers to participation. This can undermine the democratic ideal of equal political voice and representation, as marginalised groups or those with limited economic resources may be less able to engage meaningfully in democratic processes.

5. Conflicts of interest: Capitalist economies rely on profit-maximising behaviour, which may run counter to certain democratic goals. For instance, economic actors may prioritise short-term profits over long-term societal or environmental well-being. Democratic decision-making often requires considering broader societal interests, including sustainability, social justice, and the needs of future generations. Conflicts can arise when economic interests clash with democratic principles, potentially undermining the pursuit of collective well-being and the long-term interests of society.

Recognising the potential conflicts between economic interests and democratic decision-making processes is essential for maintaining a healthy balance between capitalism and democracy. It underscores the importance of robust institutions, transparency, campaign finance reform, and mechanisms to mitigate undue influence and power imbalances. By addressing these conflicts, societies can strive for a more equitable and inclusive democratic system that ensures broad representation and safeguards against the dominance of narrow economic interests.

Economics Essay 30: Quantitative Easing

 Discuss whether a reversal of QE is likely to be economically beneficial.

Quantitative Easing (QE) is an unconventional monetary policy tool used by central banks to stimulate the economy when traditional monetary policy measures, such as lowering interest rates, are insufficient. It involves the central bank purchasing government bonds or other financial assets from commercial banks and injecting liquidity into the economy. The goal of QE is to lower borrowing costs, increase lending, and encourage spending to stimulate economic growth.

When evaluating the potential economic benefits of reversing QE, several factors need to be considered:

1. Economic Growth: Reversing QE has the potential to impact economic growth. As liquidity is withdrawn from the economy, it may lead to tighter financial conditions, higher borrowing costs, and reduced consumer and business spending. This could result in a slowdown in economic growth or even a contraction in some cases.

2. Unemployment: The impact of reversing QE on unemployment is complex and depends on the specific circumstances. Tightening liquidity may lead to reduced business investment and hiring, potentially leading to job losses. However, if reversing QE is undertaken to control inflationary pressures, it can help maintain price stability, which in turn can support long-term economic growth and employment stability.

3. Inflation: Reversing QE can be used as a tool to control inflationary pressures in the economy. If the central bank perceives that inflation is becoming a concern due to excessive money supply, reversing QE can help tighten monetary policy and prevent inflation from spiraling out of control. This can contribute to price stability and maintain the purchasing power of consumers.

4. Balance of Payments: Reversing QE may have implications for a country's balance of payments. As liquidity is withdrawn from the economy, it could result in a stronger domestic currency, which may impact export competitiveness. A stronger currency can make exports relatively more expensive and imports cheaper, potentially leading to a deterioration in the trade balance and a higher current account deficit.

5. Financial Markets: The reversal of QE can have significant impacts on financial markets. Selling off large amounts of assets acquired through QE may lead to market disruptions and increased volatility. Investors and market participants may need to adjust their investment strategies and asset allocations in response to the changing liquidity conditions, which could impact asset prices and overall market stability.

6. Confidence and Expectations: Reversing QE requires clear and effective communication from the central bank to manage market expectations. Changes in monetary policy can influence investor and consumer confidence. If the central bank successfully conveys a sense of stability and a well-managed transition, it can help maintain confidence in the economy and minimize disruptions.

It's important to note that the effects of reversing QE can vary depending on the specific economic conditions, the timing and pace of the reversal, and the effectiveness of the central bank's communication and policy implementation. Careful assessment and consideration of the potential impacts on growth, unemployment, inflation, balance of payments, and financial markets are necessary to ensure that the benefits outweigh any potential drawbacks.

While the reversal of QE may help address inflationary pressures and promote long-term economic stability, it also carries potential risks. The withdrawal of liquidity can tighten financial conditions, leading to slower economic growth and potential job losses. Additionally, the impact on financial markets and investor confidence should be closely monitored to mitigate any disruptions.

Furthermore, free market fundamentalists argue that the market should be left to correct itself without excessive government intervention, including unconventional monetary policies like QE. They believe that market forces should determine interest rates, asset prices, and economic growth without central bank intervention.

In conclusion, the reversal of QE should be carefully evaluated, taking into account its potential impacts on economic growth, unemployment, inflation, balance of payments, and financial markets. The timing, pace, and communication of the reversal are crucial to managing market expectations and minimizing disruptions. While QE can provide short-term stimulus, its long-term effects and potential risks should be carefully considered in the context of specific economic conditions.

Economics Essay 29: Quantity Theory of Money

Using the quantity theory of money, explain why an increase in the money supply might cause a rise in inflation.

The quantity theory of money provides an explanation for the relationship between the money supply and inflation. According to this theory, an increase in the money supply leads to an increase in the overall price level in an economy. Here's how it works:

The quantity theory of money is based on the equation of exchange, which states that the total value of transactions in an economy is equal to the money supply multiplied by the velocity of money (the rate at which money circulates) equals the average price level multiplied by the real output or quantity of goods and services produced.

In equation form, it can be represented as: MV = PQ, where M is the money supply, V is the velocity of money, P is the price level, and Q is the quantity of goods and services produced.

When the money supply increases, assuming that the velocity of money and the quantity of goods and services produced remain constant in the short run, the equation implies that either prices (P) or the number of transactions (Q) must rise.

1. Increase in Prices (P): With an increase in the money supply, if the quantity of goods and services produced (Q) remains constant, the increase in the money supply creates a situation where there is more money available to purchase the same amount of goods and services. This excess money leads to an increase in demand relative to supply, putting upward pressure on prices.

2. Increase in Quantity of Transactions (Q): Alternatively, an increase in the money supply may lead to an increase in the quantity of goods and services produced (Q) in response to the higher demand resulting from the increased money supply. This increase in Q helps accommodate the additional money supply in the economy.

In both cases, the outcome is an increase in the overall price level, which is commonly referred to as inflation.

It's important to note that the quantity theory of money assumes a ceteris paribus (all else being equal) condition, which means it simplifies the analysis by holding other factors constant. In reality, there are numerous other factors that can influence inflation, such as changes in production costs, expectations, government policies, and external shocks.

Nonetheless, the quantity theory of money provides a fundamental understanding of how an increase in the money supply can lead to inflationary pressures in an economy.

Deficits can matter, sometimes

Philip Coggan in The FT

Deficits don’t matter. This quote comes not from some spendthrift European socialist but reputedly from the distinctly conservative Dick Cheney, vice-president of the US from 2001 to 2009. 

According to an account by former Treasury secretary Paul O’Neill, in 2002 Cheney cited the Reagan administration as evidence for his thesis; the national debt tripled on the Republican’s watch in the 1980s but the US economy boomed and bond yields fell sharply. 

In the 20 years since Cheney’s remark, US federal debt has roughly doubled as a proportion of GDP. But 10-year Treasury bond yields are no higher than they were two decades ago; indeed they have spent much of the intervening period at much lower levels, even as debt has soared. The continuing brouhaha over the US debt ceiling has nothing to do with the willingness of markets to buy American debt; any everything to do with the willingness of politicians to honour their government’s commitments. 

However, Cheney’s sentiments have not always been borne out elsewhere. Over the past nine months the British government has discovered the problems that can occur when funding costs suddenly increase. And that has rekindled the debate over the ability of governments to run prolonged deficits. 

In one camp are the spiritual descendants of Margaret Thatcher, the former British prime minister who sought to balance budgets, arguing that “good Conservatives always pay their bills”. Modern budget hawks often say that governments should not pass on the burden of debt repayment to the next generation. Many also argue that budget deficits are caused by excessive government spending and that reducing this spending is not only prudent but will fuel economic growth. In the other camp are the majority of economists, who argue that unlike individuals, governments are in effect immortal and can rely on inflation, or future generations, to pay down their debts. 

They point out that government debt, as a proportion of gross domestic product, was very high (in both the US and the UK) in the aftermath of the second world war. That debt proved no barrier to rapid economic growth. Furthermore, ageing populations in the developed world mean there has been a “savings glut” as citizens put aside money for their retirements, making it easy to fund deficits. 

But the freedom of governments to issue debt comes with a couple of caveats. First, a country must be able to issue debt in its own currency. Many a developing country has discovered the dangers of issuing debt in dollars. If that country is forced to devalue its currency, then the cost of servicing the dollar debt soars. Secondly, countries need a central bank that is willing to support its government by buying its debt. The quantitative easing programmes of such buying has undoubtedly made it easier for governments to run deficits. 

In the eurozone crisis of 2010-12, deficits did matter for countries like Greece and Italy. Their bond yields soared as investors feared that the indebted countries might be forced to leave the eurozone. This would have either forced governments to default, or attempt to re-denominate the debt into their local currency. Greece turned to neighbours for help but found that other countries were unwilling to provide required support that unless Athens reined in its budget deficits. 

To many Eurosceptics, that proved the folly of joining the single currency. Britain was free of such constraints since it issued debt in its own currency and had a central bank that would undertake QE. Given those freedoms, the financial crisis of last autumn, which followed the mini-Budget proposed by the shortlived Liz Truss administration, was even more of a shock. 

While Truss tried to echo Thatcher’s imagery, she rejected the budgetary prudence of the Treasury as “abacus economics”. She argued that slashing taxes would lead to faster economic growth so that the deficit would disappear of its own accord as government revenues rose.  

However, the markets did not swallow the argument. The mini-Budget was followed by a spectacular sell-off in sterling and UK government bonds. The latter may have stemmed from the leveraged bets made by British pension funds on bonds. Still, the Truss team’s economic analysis failed to account for this possibility. 

Investor confidence in British economic policy had already been dented by the Brexit vote and by the rapid turnover of prime ministers and chancellors. The problem has not gone away. Data released this week showed that Britain was still struggling to contain inflation and gilt yields jumped back towards the levels reached after the mini-Budget. 

So Cheney’s aphorism needs amending. Deficits don’t matter if the government borrows in its own currency, and also has a friendly central bank, a steady inflation rate and the confidence of the financial markets. It also requires a continuation of the global savings glut. Those conditions mean there is plenty of scope for future governments to get into trouble.

After the easy money: a giant stress test for the financial system

John Plender in The FT 

Five weeks after the collapse of Silicon Valley Bank, there is no consensus on whether the ensuing financial stress in North America and Europe has run its course or is a foretaste of worse to come. 

Equally pressing is the question of whether, against the backdrop of still high inflation, central banks in advanced economies will soon row back from monetary tightening and pivot towards easing. 

These questions, which are of overwhelming importance for investors, savers and mortgage borrowers, are closely related. For if banks and other financial institutions face liquidity crises when inflation is substantially above the central banks’ target, usually of about 2 per cent, acute tension arises between their twin objectives of price stability and financial stability. In the case of the US Federal Reserve, the price stability objective also conflicts with the goal of maximum employment. 

The choices made by central banks will have a far-reaching impact on our personal finances. If inflation stays higher for longer, there will be further pain for those who have invested in supposedly safe bonds for their retirement. If the central banks fail to engineer a soft landing for the economy, investors in risk assets such as equities will be on the rack. And for homeowners looking to refinance their loans over the coming months, any further tightening by the Bank of England will feed into mortgage costs. 

The bubble bursts 

SVB, the 16th largest bank in the US, perfectly illustrates how the central banks’ inflation and financial stability objectives are potentially in conflict. It had been deluged with mainly uninsured deposits — deposits above the official $250,000 insurance ceiling — that far exceeded lending opportunities in its tech industry stamping ground. So it invested the money in medium and long-dated Treasury and agency securities. It did so without hedging against interest rate risk in what was the greatest bond market bubble in history. 

The very sharp rise in policy rates over the past year pricked the bubble, so depressing the value of long-dated bonds. This would not have been a problem if depositors retained confidence in the bank so that it could hold the securities to maturity. Yet, in practice, rich but nervous uninsured depositors worried that SVB was potentially insolvent if the securities were marked to market. 

 An inept speech by chief executive Greg Becker on March 9 quickly spread across the internet, causing a quarter of the bank’s deposit base to flee in less than a day and pushing SVB into forced sales of bonds at huge losses. The collapse of confidence soon extended to Signature Bank in New York, which was overextended in property and increasingly involved in crypto assets. Some 90 per cent of its deposits were uninsured, compared with 88 per cent at SVB. 

Fear spread to Europe, where failures of risk management and a series of scandals at Credit Suisse caused deposits to ebb away. The Swiss authorities quickly brokered a takeover by arch rival UBS, while in the UK the Bank of England secured a takeover of SVB’s troubled UK subsidiary by HSBC for £1. 

These banks do not appear to constitute a homogeneous group. Yet, in their different ways, they demonstrate how the long period of super-low interest rates since the great financial crisis of 2007-09 introduced fragilities into the financial system while creating asset bubbles. As Jon Danielsson and Charles Goodhart of the London School of Economics point out, the longer monetary policy stayed lax, the more systemic risk increased, along with a growing dependence on money creation and low rates. 

The ultimate consequence was to undermine financial stability. Putting that right would require an increase in the capital base of the banking system. Yet, as Danielsson and Goodhart indicate, increasing capital requirements when the economy is doing poorly, as it is now, is conducive to recession because it reduces banks’ lending capacity. So we are back to the policy tensions outlined earlier. 

Part of the problem of such protracted lax policy was that it bred complacency. Many banks that are now struggling with rising interest rates had assumed, like SVB, that interest rates would remain low indefinitely and that central banks would always come to the rescue. The Federal Deposit Insurance Corporation estimates that US banks’ unrealised losses on securities were $620bn at the end of 2022. 

A more direct consequence, noted by academics Raghuram Rajan and Viral Acharya, respectively former governor and deputy governor of the Reserve Bank of India, is that the central banks’ quantitative easing since the financial crisis, whereby they bought securities in bulk from the markets, drove an expansion of banks’ balance sheets and stuffed them with flighty uninsured deposits. 

Rajan and Acharya add that supervisors in the US did not subject all banks to the same level of scrutiny and stress testing that they applied to the largest institutions. So these differential standards may have caused a migration of risky commercial real estate loans from larger, better-capitalised banks to weakly capitalised small and midsized banks. There are grounds for thinking that this may be less of an issue in the UK, as we shall see. 

A further vulnerability in the system relates to the grotesque misallocation of capital arising not only from the bubble-creating propensity of lax monetary policy but from ultra-low interest rates keeping unprofitable “zombie” companies alive. The extra production capacity that this kept in place exerted downward pressure on prices. 

Today’s tighter policy, the most draconian tightening in four decades in the advanced economies with the notable exception of Japan, will wipe out much of the zombie population, thereby restricting supply and adding to inflationary impetus. Note that the total number of company insolvencies registered in the UK in 2022 was the highest since 2009 and 57 per cent higher than 2021. 

A system under strain  

In effect, the shift from quantitative easing to quantitative tightening and sharply increased interest rates has imposed a gigantic stress test on both the financial system and the wider economy. What makes the test especially stressful is the huge increase in debt that was encouraged by years of easy money. 

William White, former chief economist at the Bank for International Settlements and one of the few premier league economists to foresee the great financial crisis, says ultra easy money “encouraged people to take out debt to do dumb things”. The result is that the combined debt of households, companies and governments in relation to gross domestic product has risen to levels never before seen in peacetime. 

All this suggests a huge increase in the scope for accidents in the financial system. And while the upsets of the past few weeks have raised serious questions about the effectiveness of bank regulation and supervision, there is one respect in which the regulatory response to the great financial crisis has been highly effective. It has caused much traditional banking activity to migrate to the non-bank financial sector, including hedge funds, money market funds, pensions funds and other institutions that are much less transparent than the regulated banking sector and thus capable of springing nasty systemic surprises. 

An illustration of this came in the UK last September following the announcement by Liz Truss’s government of unfunded tax cuts in its “mini” Budget. It sparked a rapid and unprecedented increase in long-dated gilt yields and a consequent fall in prices. This exposed vulnerabilities in liability-driven investment funds in which many pension funds had invested in order to hedge interest rate risk and inflation risk. 

Such LDI funds invested in assets, mainly gilts and derivatives, that generated cash flows that were timed to match the incidence of pension outgoings. Much of the activity was fuelled by borrowing. 

UK defined-benefit pension funds, where pensions are related to final or career average pay, have a near-uniform commitment to liability matching. This led to overconcentration at the long end of both the fixed-interest and index-linked gilt market, thereby exacerbating the severe repricing in gilts after the announcement. There followed a savage spiral of collateral calls and forced gilt sales that destabilised a market at the core of the British financial system, posing a devastating risk to financial stability and the retirement savings of millions. 

This was not entirely unforeseen by the regulators, who had run stress tests to see whether the LDI funds could secure enough liquidity from their pension fund clients to meet margin calls in difficult circumstances. But they did not allow for such an extreme swing in gilt yields. 

Worried that this could lead to an unwarranted tightening of financing conditions and a reduction in the flow of credit to households and businesses, the BoE stepped in to the market with a temporary programme of gilt purchases. The purpose was to give LDI funds time to build their resilience and encourage stronger buffers to cope with future volatility in the gilts market. 

The intervention was highly successful in terms of stabilising the market. Yet, by expanding its balance sheet when it was committed to balance sheet shrinkage in the interest of normalising interest rates and curbing inflation, the BoE planted seeds of doubt in the minds of some market participants. Would financial stability always trump the central bank’s commitment to deliver on price stability? And what further dramatic repricing incidents could prompt dangerous systemic shocks? 

Inflation before all? 

The most obvious scope for sharp repricing relates to market expectations about inflation. In the short term, inflation is set to fall as global price pressures fall back and supply chain disruption is easing, especially now China continues to reopen after Covid-19 lockdowns. The BoE Monetary Policy Committee’s central projection is for consumer price inflation to fall from 9.7 per cent in the first quarter of 2023 to just under 4 per cent in the fourth quarter. 

The support offered by the Fed and other central banks to ailing financial institutions leaves room for a little more policy tightening and the strong possibility that this will pave the way for disinflation and recession. The point was underlined this week by the IMF, which warned that “the chances of a hard landing” for the global economy had risen sharply if high inflation persists. 

Yet, in addition to the question mark over central banks’ readiness to prioritise fighting inflation over financial stability, there are longer-run concerns about negative supply shocks that could keep upward pressure on inflation beyond current market expectations, according to White. For a start, Covid-19 and geopolitical friction are forcing companies to restructure supply lines, increasing resilience but reducing efficiency. The supply of workers has been hit by deaths and long Covid. 

White expects the production of fossil fuels and metals to suffer from recently low levels of investment, especially given the long lags in bringing new production on stream. He also argues that markets underestimate the inflationary impact of climate change and, most importantly, the global supply of workers is in sharp decline, pushing up wage costs everywhere. 

Where does the UK stand in all this? The resilience of the banking sector has been greatly strengthened since the financial crisis of 2007-08, with the loan-to-deposit ratios of big UK banks falling from 120 per cent in 2008 to 75 per cent in the fourth quarter of 2022. Much more of the UK banks’ bond portfolios are marked to market for regulatory and accounting purposes than in the US. 

The strength of sterling since the departure of the Truss government means the UK’s longstanding external balance sheet risk — its dependence on what former BoE governor Mark Carney called “the kindness of strangers” — has diminished somewhat. Yet huge uncertainties remain as interest rates look set to take one last upward step. 

Risks for borrowers and investors 

For mortgage borrowers, the picture is mixed. The BoE’s Financial Policy Committee estimates that half the UK’s 4mn owner-occupier mortgages will be exposed to rate rises in 2023. But, in its latest report in March, the BoE’s FPC says its worries about the affordability of mortgage payments have lessened because of falling energy prices and the better outlook for employment. 

The continuing high level of inflation is reducing the real value of mortgage debt. And, if financial stability concerns cause the BoE to stretch out the period over which it brings inflation back to its 2 per cent target, the real burden of debt will be further eroded. 

For investors, the possibility — I would say probability — that inflationary pressures are now greater than they have been for decades raises a red flag, at least over the medium and long term, for fixed-rate bonds. And, for private investors, index-linked bonds offer no protection unless held to maturity. 

That is a huge assumption given the unknown timing of mortality and the possibility of bills for care in old age that may require investments to be liquidated. Note that the return on index-linked gilts in 2022 was minus 38 per cent, according to consultants LCP. When fixed-rate bond yields rise and prices fall, index-linked yields are pulled up by the same powerful tide. 

Of course, in asset allocation there can be no absolute imperatives. It is worth recounting the experience in the 1970s of George Ross Goobey, founder of the so-called “cult of the equity” in the days when most pension funds invested exclusively in gilts. 

While running the Imperial Tobacco pension fund after the war he famously sold all the fund’s fixed-interest securities and invested exclusively in equities — with outstanding results. Yet, in 1974, he put a huge bet on “War Loan” when it was yielding 17 per cent and made a killing. If the price is right, even fixed-interest IOUs can be a bargain in a period of rip-roaring inflation. 

A final question raised by the banking stresses of recent weeks is whether it is ever worth investing in banks. In a recent FT Money article, Terry Smith, chief executive of Fundsmith and a former top-rated bank analyst, says not. He never invests in anything that requires leverage (or borrowing) to make an adequate return, as is true of banks. The returns in banking are poor, anyway. And, even when a bank is well run, it can be destroyed by a systemic panic. 

Smith adds that technology is supplanting traditional banking. And, he asks rhetorically, have you noticed that your local bank branch has become a PizzaExpress, in which role, by the way, it makes more money? 

 A salutary envoi to the tale of the latest spate of bank failures. 

Do Government Bailouts of Banks Worsen Economic Conditions?

 Ruchir Sharma in The FT 

As bank runs spread, it has become clear that anyone who questions a government rescue for those caught underfoot will be tarred as a latter-day liquidationist, like those who advised Herbert Hoover to let businesses fail after the crash of 1929. 

Liquidationist is now challenging fascist as the most inaccurately thrown insult in politics. True, it’s no longer politically possible for governments not to stage rescues, but this is a snowballing problem of their own making. The past few decades of easy money created markets so large — nearing five times larger than the world economy — and so intertwined, that the failure of even a midsize bank risks global contagion. 

More than low interest rates, the easy money era was shaped by an increasingly automatic state reflex to rescue — to rescue the economy from disappointing growth even during recoveries, to rescue not only banks and other companies but also households, industries, financial markets and foreign governments in times of crisis. 

The latest bank runs show that the easy money era is not over. Inflation is back so central banks are tightening, but the rescue reflex is still gaining strength. The stronger it grows, the less dynamic capitalism becomes. In stark contrast to the minimalist state of the pre-1929 era, America now leads a rescue culture that keeps growing to new maximalist extremes. 

Today’s troubles have been compared to bank runs of the 19th century, but rescues were rare in those days. America’s founding hostility to concentrated power had left it with limited central government and no central bank. In the absence of a financial system, trust was kept at a personal, not an institutional level. Before the civil war, private banks issued their own currencies and when trust failed, depositors fled. 

Had the US Federal Reserve existed at the time, it would not have helped much. The ethos of contemporary European central banks was to help solvent banks with solid collateral — in practice they were tougher, protecting their own reserves and “turning away their correspondents in need”, as a Fed history puts it. 

A restrained government was a key feature of the industrial revolution, marked by painful downturns and robust recoveries, resulting in strong productivity and higher per capita income growth. Right into the 1960s and 1970s, resistance to state rescues still ran deep, whether the supplicant was a major bank, a major corporation or New York City. 

Though the early 1980s is seen as a pivotal moment of broader government retreat, in fact this era was marked by the rise of rescue culture when Continental Illinois became the first US bank deemed too big to fail. In a move that was radical then, reflexive now, the Federal Deposit Insurance Corporation extended unlimited protection to Continental depositors — just as it has done for SVB depositors. 

Recent bank runs have been compared to the savings and loan crisis of the 1980s. Triggered in part by regulation that made it impossible for S&Ls to compete in an environment of rising rates, the crisis was resolved by regulators who wound down more than 700 of these “thrifts” at a cost to taxpayers of about $130bn. The first preventive rescue came in the late 1990s, when the Fed organised support for a hedge fund deeply tied to foreign markets, in order to avoid the threat of a systemic financial crisis. 

Those rescues pale next to 2008 and 2020, when the Fed and Treasury smashed records for trillions of dollars created or extended in loans and bailouts to thousands of companies across finance and other industries at home and abroad. In each crisis, rescues held down the corporate default rate to levels that were unexpectedly low, compared with past patterns. They are doing the same now even as rates rise and bank runs begin. 

The hazards are not just moral or speculative, as many insist — they are practical and present. The rescues have led to a massive misallocation of capital and a surge in the number of zombie firms, which contribute mightily to weakening business dynamism and productivity. In the US, total factor productivity growth fell to just 0.5 per cent after 2008, down from about 2 per cent between 1870 and the early 1970s. 

Instead of re-energising the economy, the maximalist rescue culture is bloating and thereby destabilising the global financial system. As fragility grows, each new rescue hardens the case for the next one. 

No one who thinks about it for more than a minute can wax nostalgic for the painful if productive chaos of the pre-1929 era. But too few policymakers recognise that we are at an opposite extreme; constant rescues undermine capitalism. Government intervention eases the pain of crises but over time lowers productivity, economic growth and living standards.

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The Fed Chair must acknowledge that free money has made asset prices unsustainably high

Gillian Tett in The FT 

This week financiers’ eyes have been firmly fixed on the Federal Reserve. No wonder. On Wednesday the US central bank raised rates at the most aggressive pace for 22 years, as Jay Powell, Fed chair, finally acknowledged the obvious: inflation is “much too high”. 

But as investors parse Powell’s words, they should spare a thought for a central bank on the other side of the world: the Reserve Bank of New Zealand. 

In recent years, this tiddler has often been an unlikely harbinger of bigger global trends. In the late 20th century, for instance, the RBNZ pioneered inflation targeting. More recently, it embraced climate reporting ahead of most peers. 

Last year, it started tightening policy before most counterparts. And this week it went further: its latest financial stability report warns of a “plausible” chance of a “disorderly” decline in house prices, as the era of free money ends. 

Unsurprisingly, the RBNZ also said it hopes to avoid a destabilising crash. But the key point is this: the Kiwi central bankers know they have an asset bubble on their hands, since property prices have jumped 45 per cent higher in the last two years and “are still estimated to be above sustainable levels”. This reflects both ultra-low rates and dismally bad domestic housing policies. 

And it is now telling the public and politicians that this bubble needs to deflate, hopefully smoothly. There is no longer a Kiwi “put” — or a central bank safety net to avoid price falls. 

If only the Fed would be as honest and direct. On Wednesday Powell tried to engage in some plain speaking, by telling the American people that inflation was creating “significant hardship” and that rates would need to rise “expeditiously” to crush this. He also declared “tremendous admiration” for his predecessor Paul Volcker, who hiked rates to tackle inflation five decades ago, even at the cost of a recession. 

However, what Powell did not do was discuss asset prices — let alone admit that these have recently been so inflated by cheap money that they are likely to fall as policy shifts. 

A central bank purist might argue that this omission simply reflects the nature of Powell’s mandate, which is to “promote maximum employment and stable prices for the American people”, as he said on Wednesday. In any case, evidence about the short-term risk of asset price falls is mixed. 

Yes, the S&P 500 has dipped into correction territory twice this year, with notable declines in tech stocks. However, the American stock indices actually rallied 3 per cent on Wednesday, after Powell struck a more dovish tone than expected by ruling out a 75 basis point rise at the next meeting. 

And there is no sign of any fall in American property prices right now. On the contrary, the Case-Shiller index of home prices is 34 per cent higher than it was two years ago, according to the most recent (February) data. 

However, it beggars belief that Powell could crush consumer price inflation while leaving asset prices intact. After all, one key factor that has raised these prices to elevated levels is that the Federal Reserve’s $9tn balance sheet almost doubled during the COVID-19 pandemic (and has expanded it nine-fold since 2008.) 

And, arguably, the most significant aspect of the Fed’s decision on Wednesday is not that 50bp rise in rates, but the fact that it pledged to start trimming its holdings of mortgages and treasuries by $47.5bn each month, starting in June — and accelerate this to a $90bn monthly reduction from September. 

According to calculations by Bank of America, this implies a $3tn balance sheet shrinkage (quantitative tightening, in other words) over the next three years. And it is highly unlikely that the impact of this is priced in. 

After all, QT on this scale has never occurred before, which means that neither Fed officials nor market analysts really know what to expect in advance. Or as Matt King, an analyst at Citibank, observes: “The reality is that tightening hasn’t really started yet.” 

Of course, some economists might argue that there is no point in the Fed spelling out this risk to asset prices now, given how this might hurt confidence. That would not make Powell popular with a White House that is facing a difficult election, Nor would it help him achieve his stated goal of a “soft” (or “softish”) economic landing, given that consumer sentiment has wobbled in recent months. 

But the reason why plain speaking is needed is that a dozen years of ultra-loose policy has left many investors (and households) addicted to free money, and acting as if this is permanent. Moreover, since the Fed has repeatedly rescued investors from a rapid asset price correction in recent years — most recently in 2020 — many investors have an innate assumption that there is a Fed “put”. 

So if Powell truly wants to emulate his hero Volcker, and take tough measures for long-term economic health, he should take a leaf from the Kiwi book, and tell the American public and politicians that many asset prices have been pumped unsustainably high by free money. 

That might not win him fans in Congress. But nobody ever thought it would be easy to deflate a multitrillion dollar asset price bubble. And the Fed has a better chance of doing this smoothly if it starts gently and early. Wednesday’s rally shows the consequences of staying silent.

Solutions for Inflation? Capitalism Faces a Dead End?

 

Global Capitalism: Inflation: Causes, Effects, & Outlook

 

Boris Johnson claims the UK is rooting out dirty Russian money. That’s ludicrous

 Oliver Bullough in The Guardian

We were warned about Vladimir Putin – about his intentions, his nature, his mindset – and, because it was profitable for us, we ignored those warnings and welcomed his friends and their money. It is too late for us to erase our responsibility for helping Putin build his system. But we can still dismantle it and stop it coming back.

Russia is a mafia state, and its elite exists to enrich itself. Democracy is an existential threat to that theft, which is why Putin has crushed it at home and seeks to undermine it abroad. For decades, London has been the most important place not only for Russia’s criminal elite to launder its money, but also for it to stash its wealth. We have been the Kremlin’s bankers, and provided its elite with the financial skills it lacks. Its kleptocracy could not exist without our assistance. The best time to do something about this was 30 years ago – but the second best time is right now.

We journalists have long been writing about this, but it is not simply overheated rhetoric from overexcited hacks. Parliament’s intelligence and security committee wrote two years ago that our investigative agencies are underfunded, our economy is awash with dirty money, and oligarchs have bought influence at the very top of our society.

The committee heard evidence from senior law enforcement and security officials. It laid out detailed, careful suggestions for what Britain should do to limit the damage Putin has already done to our society. Instead of learning from the report and implementing its proposals, Boris Johnson delayed its publication until after the general election and then, when further delay became impossible, dismissed those who took its sober analysis seriously as “Islingtonian remainers” seeking to delegitimise Brexit.

That is the crucial context for Johnson’s ludicrous claim this week to the House of Commons that no government could “conceivably be doing more to root out corrupt Russian money”. That is not only demonstrably untrue, it is an inversion of reality. On leaving the European Union, we were told that we could launch our own independent sanctions regime – and this week we saw the fruit of it: a response markedly weaker than those of Brussels and Washington.

The Liberal Democrat MP Layla Moran, speaking with parliamentary privilege on Tuesday, listed the names of 35 alleged key Putin “enablers” whom the Russian opposition politician Alexei Navalny has asked to be sanctioned. Blocking the assets of everyone on that list and their close relatives would be a truly significant response from Johnson to the gravity of the situation. But it would still only be a start.

Relying solely on sanctions now is like stamping on a car’s accelerator when you’ve failed for years to maintain the engine, pump up the tyres or fill up the tank, yet still expect it to hit 95mph. Other announcements in the last couple of days have amounted to nothing more than painting on go-faster stripes. Tackling the UK’s role in enabling Putin’s kleptocracy, and containing the threat his allies pose to democracy here and elsewhere, will require far more than just banning golden visas or Kremlin TV stations.

For a start, we need to know who owns our country. Some 87,000 properties in England and Wales are owned via offshore companies – which prevents us seeing who their true owners are or if they were bought with criminal money. Companies House makes no checks on registrations, which is why UK shell structures have featured in most Russian money-laundering scandals. Imposing transparency on the ownership of dirty money in this way would strike at the heart of the London money-laundering machine. Governments have promised to do this “when parliamentary time allows” for years, yet the time has never been found, and instead they’ve listened to concerns from the City that such regulations would harm its competitiveness.

Above all, we need to fund our enforcement agencies as generously as oligarchs fund their lawyers: you can’t fight grand corruption on the cheap. Even good policies of recent years, such as the “unexplained wealth orders” of 2017, which were designed to tackle criminally owned assets hidden behind clever shell structures, have largely failed because investigators lack the funds to use them. We must spend what it takes to drive kleptocratic cash out of the country.

Johnson is not the first prime minister to fail to rise to the challenge – Tony Blair and David Cameron both schmoozed with Putin even when it was obvious what kind of a leader he was. And I don’t think Johnson is personally corrupt or tainted by Russian money; he’s lazy, flippant and unwilling to launch expensive, laborious initiatives that will bring results only long after he himself has left office and is unable to take the credit for them. It is time, however, for his colleagues to step up and force him into action. This is a serious moment, and it requires serious people willing to invest in the long-term security of our country and the future of democracy everywhere.

Njan Prakashan in Punjab

 

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