Why Robin Hood would be the better central banker
By Graeme Maxton, originally published by Perspective Daily (click here to get to the original article).
Graeme Maxton is the Secretary General of the Club of Rome, a global network of renowned independent thinkers dedicated to addressing the challenges facing humanity. He also is the co-author of »Ein Prozent ist genug«, currently a no. 1 bestseller in Germany.
Since the financial crisis in 2008, central bankers and economists in Europe, America, Japan and the UK have introduced 2 largely experimental economic policies – ultra-low interest rates and Quantitative Easing, or QE. They have done this, they say, to boost economic growth. If struggling economies are injected with new money, goes the thinking, demand will rise, increasing the consumption of goods and services. This will create new jobs, which will reduce inequality and kick off a virtuous cycle, putting the economy back on a healthy and sustainable path.
Similarly, central bankers tell us, if interest rates are cut sufficiently low, people will no longer want to save money. They will borrow and spend it instead. This will stimulate new demand and lead to faster economic growth, too.
According to policy makers, both of these ideas also help countries avoid another problem: deflation. This is something greatly feared by central bankers and economists because there is no cure. It is a situation in which prices fall steadily over months or even years. People delay spending (because whatever they are buying will be cheaper next month) and this pushes the economy into a spiral of slowing demand, mounting unemployment and decline.
This is the thinking behind these strange policies, which have been so enthusiastically supported and promoted by many seemingly wise people in recent years.
Unfortunately, this thinking is entirely wrong. More unfortunate, perhaps, is the fact, that the bankers and policy makers who have promoted these ideas have not understood their true impact, which is why they stick to them. This is also why they have been unable to explain why the policies have not worked as they promised during the last 8 years.
To understand what is actually happening (and maybe even help politicians understand), we need to rewind our economic memories back to the financial crisis.
History of a finance crisis and after
When the 2008 finance crash hit, the US housing bubble burst and Lehman Brothers and other financial institutions went bankrupt, the entire financial system was in danger of collapse. The world’s biggest bank at the time, The Royal Bank of Scotland, found itself in so much difficulty that it was nationalised by the British government, as were others in the US and Europe. As well as buying bank stocks to support their share prices and trying to stabilise the economy by providing incentives to businesses, many governments and central banks offered unlimited lending facilities to commercial banks – at ultra-low rates of interest. This allowed them to borrow as much money as they needed to stay afloat and almost no one, except the central bankers, would see how much trouble they were really in.
These measures were originally planned to be temporary, to tide the banking system over for a few years, until the economy started growing again and commercial banks were able to stand on their own 2 feet.
Unfortunately, things have not worked out as intended. The economy in most rich world countries has not bounced back and many commercial banks remain almost as financially comatose as they were in 2008.
At the start, QE worked like this: central banks would buy the debts of commercial banks, usually their mortgage-backed securities, many of which were losing value. The policy then gradually morphed into central banks buying bank bonds, which are a form of debt, to encourage them to lend more, to boost economic growth.
How were central banks able to do this? Where did they raise the money? Through taxes?
How much was »printed«?
Certainly not. They simply printed new money, though even this is a misnomer for no printing presses were required. They basically changed numbers on balance sheets, on computers, boosting the balance sheets of the commercial banks.
It is important to understand that the original reason central banks adopted this radical printing money policy was not to boost the economy. It was to save the banking system. Only once the commercial banks became slightly more stable, and it became clear that the economy was still not growing, did central banks continue printing money, this time in an effort to stimulate economic growth.
And they did this on a staggering scale.
Between 2008 and October 2014, the United States’ central bank, The Federal Reserve, printed between $75 billion and $85 billion and injected it into the economy every month. Cumulatively, it created $4.5 trillion – more than a quarter of America’s annual GDP. This was the same as adding another Australia, India and Spain to the world economy.
The British government did much the same, creating $500 billion, while the Bank of Japan and the European Central Bank (ECB) also printed many hundreds of billions of yen and euros – and continue to print them today, in 2016.
Together, these countries have injected so much money into the global financial system since 2008 that it has been like adding another China. If this money had been converted to demand and output, it would have increased the GDP of these countries by more than 25% between 2008 and 2015. Yet their GDP grew by just 11%.
Why was there this shortfall?
Where did all the money go?
The reason for that difference is that much of the money created was simply kept by banks, to make them financially stable again, and most of the rest was used to invest, speculatively. Banks used the money to buy property, stocks and shares, raw materials like palm oil and rubber, art, wine and old-timer cars. They did not lend it to people and businesses, as the policy makers and central bankers who promoted the idea had expected. They went on a spending spree.
This is one of the main reasons why the prices of shares, property and wine have risen so much (and been so volatile) over the last 6 or 7 years. There were huge quantities of money washing around the economic system and those who controlled it tried to make some sort of return. This boosted the prices of all sorts of assets. It is not because there was new underlying demand for many of these items. It was because bankers chose to buy them, speculatively, in the hope that their price would rise and they would make a profit.
Little of the money created by central banks was used to boost the real economy. In the US, more than 80% was retained by the banks. The money did not go to ordinary people or small and mid-sized businesses. And it certainly did not go to all those people who are unemployed or who lacked of income. That would have been a much more effective way to boost the economy. If the unemployed or poor had been given the money, they would have spent it immediately – and created the demand that was needed.
What happened instead is that money was created out of thin air by central bankers and paid to commercial bankers, allowing them to get richer.
The story with very low and negative interest rates is similar.
Pay the bank to keep my money
Since the 2008 crisis, interest rates in much of the rich world have fallen to their lowest levels – ever. Since the Bank of England was founded in 1694, for example, it has never offered lower interest rates than today. Several European countries and Japan even have negative rates for professional investors today, which is unprecedented (and logically strange). Consumers, when lucky, can still get 1–2% interest – a margin encouraging them to spend instead of saving their money.
Again, the consequences of lowering the costs of borrowing like this have been that bankers and the rich have gained the most, especially in the US. Low interest rates have not boosted broader economic spending, or certainly not by much. Rather, they have boosted commercial bank earnings, lowered the costs of government borrowing and increased business profits as well as the income of shareholders.
Commercial banks have boosted their profits because their margins have gone up. Put simply, they can borrow for almost nothing, and then lend to consumers and businesses at whatever rate they can get away with. Credit cards that offer 12% interest rates may seem like a bargain to consumers used to even higher rates, but for the credit card issuers they are like a licence to print money when they can finance this lending almost for free.
Many big corporations have also gained from ultra-low interest rates, through lower interest payments. This privilege did however not translate into more jobs, wage increases or research and development. Rather it was used to boost profits, pay shareholders and buy up their own company shares. Financial investors, such as venture capitalists and hedge funds, have been able to borrow more cheaply too, allowing them to buy up weak companies. Again, this has allowed wealthy individuals to get richer, because they can acquire assets more cheaply.
Rich-world households have been the main losers from the low interest rate policy. According to a study done by management consultancy McKinsey, the rich world’s householders lost $630 billion in interest income between 2007 and the end of 2013. European banks and life-insurance companies have also lost out, due to the decline in interest income, and many pension funds have run into difficulties.
The main beneficiaries of the low interest rate policy have been the wealthy, especially in the United States, and the finance industry, again mostly in the US.
In effect then, super-low interest rates have increased the flow of money from those who borrow (generally, the poor) to those who lend (generally, the rich), widening inequality even more.
How could »printing« money help?
This is not to say that low interest rate policies and printing money cannot be used to generate economic growth. It is just that these strange policies have to be applied differently. Rather than printing money and giving it to banks and the rich, or helping the rich borrow more cheaply, the policies should be focussed instead on those who would benefit the most, on the poor and unemployed.
There are several ways this can be achieved. Most obviously welfare benefits, for the unemployed, pensioners and sick, can be increased, to provide them with something like a guaranteed basic income. As well as boosting spending, this has several other advantages. It tends to increase the wages of the lowest paid (why would they work if they can get an income to stay at home), and it makes a transition to a more sustainable economic system easier, just like transforming to a more sustainable energy system: If people no longer need to worry about losing their jobs, because they can still feed their families, they will be more open to industrial change and an economic transition.
This has been done before, in the 1930s in the United States, when the government printed money to pay workers to build roads and national parks under President Roosevelt’s »New Deal«. The workers spent what they earned on food, drink, transport, and heating, creating new demand. This higher demand was spotted by businesses, who saw the profit opportunity and so built the capacity to satisfy it. Printing money helped reflate the US economy after the Great Crash.
Moreover, printing money is likely to be needed more in the future because many of the challenges that face humanity cannot be solved by privately owned businesses alone. They will require state intervention, and state funding, and some countries will need to print more money to pay for this. This is because many of the big challenges we face require collective action and investments that do not earn an income. Building sea walls to protect cities, or rebuilding bridges washed away by floods because of climate change is not very profitable.
China is doing this already.
In 2014 the People’s Congress announced that it would spend US$800 billion to clean the nation’s air and water over the following decade. This involves paying 8 million Chinese engineers and others to produce clean air and water, rather than consumer goods and services. These people will receive freshly printed money as wages which will, of course, be spent on food, housing, and entertainment and so boost domestic demand. So the effort to clean the air will work just like the stimulus packages of the United States during the Depression.
There are many areas where printing money to fund structural change makes sense: increasing our capacity to generate renewable energy, solving climate change, addressing widespread poverty, reducing migration, helping the dispossessed and protecting biodiversity. None of these can be solved by commercial enterprises alone – or in some cases at all. They need state intervention.
Worries about inflation are undue
Of course, there is a price to pay for solving our problems in this way, at least theoretically. Economists say that printing money creates inflation (though there is little sign that this theory works right now). For people in Germany, in particular, the idea of creating inflation like this might appear especially scary. But it is not, for 3 reasons:
First, the rich-world’s economy needs slightly higher inflation, because the risk of deflation is real and will become even more problematic in Germany as the population ages.
Second, slightly higher rates of inflation will gradually reduce consumption, which is also necessary if we are to get off today’s wasteful and unsustainable economic treadmill.
Finally, if printing money created too much inflation, it can be dealt with easily – because the simplest way to reduce inflation is to raise interest rates.
The current policy of printing money to boost economic growth will never work. But it could, if the money was given to those most in need. Moreover, the same policy can be used more widely, and more wisely, to solve humanity’s biggest challenges.
Printing money will not kill us, after all. But climate change will.