Only economists believe extreme monetary policy will work, says former Bank of England governor Mervyn King in the second part of our interview. But what will?
In the first part of my interview with Mervyn King, we talked about the euro area – how it got to its current miserable state and what happens next (collapse of the monetary union, if you missed it). That left us rather depressed.
In the second part I thought I’d go for something more uplifting: how do we move on from the financial crisis and today’s extraordinarily low levels of global growth? How do we make it better? I wish I could tell you this bit was less depressing. I can’t. The answer isn’t the kind of thing that King used to do: “monetary policy and monetary easing is not going to… get us back to a sustainable recovery” and any politicians who think it is are making “a very serious intellectual mistake”.
It might cover a few cracks and buy time, but it isn’t doing anything to deal with the huge disequilibriums in the world economy – the fact that some countries (mainly Germany and China) have saved too much, which has pushed interest rates down so far that the rest of us have spent far too much. And it isn’t going to stop the next decade being littered with serious debt defaults.
China is the most obvious problem. When it started down the path that got us here – fixing its currency to the US dollar at too low a rate in an effort to boost export growth – it “was not a crazy thing to do”. It was just an attempt to follow in the (successful) mercantilist footsteps of Japan. But the fact that China then “became such a big economy so quickly had major implications. Not just for the world, but for China too.”
China understands that, of course, and can see that it must shift resources from the export sector to the domestic sector. But it isn’t easy. Just like “Western politicians, they’re naturally very conscious of where the jobs would be lost but they can’t see where the jobs would be created”. Change also “requires the willingness to make big structural reforms and to give up this pretence that fixed exchange rates are a good thing”.
A zero-sum game
Of course, China isn’t the only one manipulating its exchange rate. In the absence of real global growth, everyone from Asia to Europe is trying to steal growth from everyone else. They all want to push their exchange rates down (“temporarily, of course!”) to snatch a little trade advantage. But this is a “zero-sum game” that in the end does no one any good. We need to return to accepting “movements in exchange rates brought about by markets”.
But “countries are reluctant to take that risk because they don’t know what the rest of the world is going to do”. To fix things “we need to create a type of cooperation that reassures countries that we’ll all do our bit, even though that’s going to vary from one country to another”. Sounds tricky. King agrees.
A shift back to properly floating rates inside a “plausible timescale” would, he says, have to be managed by a respected global body – the International Monetary Fund (IMF) being the obvious one. But “the IMF has become associated far too much with the political project of monetary union in Europe and that has damaged its credibility in the rest of the world”. The euro area has ended up borrowing far more, relative to the sums handed to Latin America and Asia when they had their crises.
The Europeans were “deeply sceptical” back then, yet they showed very little compunction about loading up on debt when it was their turn. “This has created a certain degree of cynicism in the rest of the world about how the IMF behaves.” If not the IMF, then what? Global cooperation without the IMF playing a stronger leadership role is unlikely, says King: the IMF needs, probably, “to change so many of its policies in order to be able to do that”.
The productivity puzzle
What else might get the show back on the road? It might sound obvious, says King – a bit of “motherhood and apple pie” – but the answer is “a sustained programme over ten years to improve the efficiency of our economy”, one that “would have the effect of leading people to believe that they genuinely would be better off in the future”. That sounds nice. But how?
All economists talk about the “productivity puzzle” – if it is a puzzle, how can it be sorted out? Or isn’t it a puzzle? Not completely, says King. Immediately after the crisis, the banking system was “reluctant to lend and that hit new businesses particularly hard”. Meanwhile, very low interest rates have pulled forward demand – cheap money persuades people to “spend today rather than tomorrow”.
So as you continually ease monetary policy, you create more concern that future demand will be weak, which hurts investment: business owners who fear a low-growth future will say: “rather than invest in capital equipment, we’ll hire more labour, because we know that if there is a downturn… we can get rid of labour quickly”.
Is it also possible that there is an interplay between the UK’s tax credit system (tax credits are benefits given to those in work) and productivity, I wonder – in that it makes labour look cheap to employers, and also actively encourages part-time work?
We were struck at MoneyWeek, for example, by the fact that McDonald’s new contracts allow staff to choose to work for the exact number of hours that work well with the tax credit system (16 and 30). It is, says King. “When tax credit systems have been introduced around the world, one… concern has always been that employers would work out how to make the taxpayer pay for a good deal of the effective wage” – one reason why governments keep hiking the minimum wage. Bad policy on bad policy.
No easy answers
So the IMF idea looks iffy, and the productivity one isn’t a fast fix either. What else? The other thing that “ought to be manageable”, says King, is getting trade going. The Doha trade round got “stuck in a rut because the major emerging-market countries didn’t want to make further progress on agriculture”, but the advanced industrialised economies really need to talk among themselves about new trade deals based on services.
The expansion of trade – and this is something we learnt after World War II – is a “real boost to productivity growth… People discover new products, new ideas, new processes. It stimulates thinking about how to improve what they’re doing.”
That could boost our economies and make people believe that they will be better off in the future, which will make them less concerned about repaying debt fast, and more likely to spend and invest today. That would make the recovery sustainable, allowing rates to rise – and the distorting effects of super-low interest rates to end.
That moves us on to pensions. One reason that we are spending less as the low rate environment drags on is because the very low investment returns available makes us (me, certainly) hysterical about building up a proper pension fund. King agrees – his worry being, like ours, that people will “gamble on the housing market” in desperation.
We talk about this and how one might invest to deal with it. But the answer is pretty simple: a “normal healthy” economy gives the opportunity to invest at positive real interest rates: around 3%-4% after inflation. This one doesn’t. If you want safety you can buy government bonds – at least you’ll get your capital back. But if you want to make what has been the norm for the last couple of hundred years on your money? You can’t. Not good.
What only economists fail to understand
So far so bad. King has good ideas, but it’s clear that the big ones will be hard to get going in a hurry. So what about debt monetisation – a kind of extreme monetary policy that many of those connected to the big central banks currently seem keen on? King isn’t keen at all.
If people see the Bank of England as acting recklessly, “irrespective of future inflation”, they will lose confidence in the bank. That’s a recipe for inflation. And if you’re going to do that you might as well just hand interest-rate policy back to politicians. Nothing will create fear of inflation, and hence inflation, faster than that. This brings us full circle.
The world is not as it was “when we sat round the table in Washington in October 2008 and said, we will do what we have to do in monetary and fiscal policy to ensure the financial system doesn’t fail. No one round that table thought that eight years later we’d still be in a position of desperately having… zero interest rates, negative in many countries, large amounts of quantitative easing, money creation.
And we did not believe that eight years on we would have failed to generate a world recovery. But that’s been the case and I think a non-economist would react to that by saying, well, I don’t really understand economics but surely monetary policy can’t therefore be the answer. And it’s only economists that seem to think it is.”