2 percent inflation is just a central bank fad

Published in the Financial Times.

Your interview with Shinzo Abe (“Japanese PM targets big reforms to cement legacy,” Oct. 8) may indicate some momentum in a fundamental shift in ideas — a shift away from the in-retrospect foolish “golden age” theory of retirement, which was invented in the 1950s. This led to the notion that, starting in their 60s, people should be paid while spending a couple of decades or more in idleness and entertaining themselves, rather than remaining productive. Mr Abe instead wants “a society where people never retire and pursue lifelong careers.” If not lifelong, perhaps, at least significantly longer.

Your article proceeds to assert dogmatically that this “will count for little if deflation is not banished” because “the Bank of Japan’s 2 percent inflation objective is still far off.” This treats the necessity of 2 percent inflation as a fact instead of a pretty dubious theory. In reality, perpetual inflation at 2 percent is merely the latest fashion in central banking ideas. It follows many other central bank fashions, which have succeeded each other over a century, going back to the gold standard. Like the “golden age” theory of retirement, I believe the “2 percent inflation forever” theory will be found wanting and replaced.

Efforts to close the ‘doom loop’ are destined to fail

Published in the Financial Times.

Thomas Huertas (“Bank holdings of sovereign debt need scrutiny,” September 7) makes very reasonable proposals of how to control the “doom loop” of government debt making the banking system more risky, while the banks make the government’s finances more risky. But the sensible reforms he recommends won’t happen and can’t happen. This is for a simple and powerful reason: the financial regulators who would have to take the actions are employees of the government which wants to expand its debt. A top priority of all governments is to be able to increase their debt as needed. The regulators will not act against this fundamental interest of their employer.

An egregious example of this problem in the U.S. context is that as the bubble inflated the banking regulators did, and still do, allow the banks to hold unlimited amounts of the debt of Fannie Mae and Freddie Mac, the government-backed mortgage firms, long since failed and in conservatorship. Moreover, the regulators allowed (and indeed promoted, through low risk-based capital requirements) banks to own and finance with deposits the preferred equity of Fannie and Freddie. These were distinctly bad ideas. But what were the poor regulators to do? Their employer, the US government, wanted to expand housing debt and leverage through Fannie and Freddie, and they went along.

Letters to Barron’s: Rediscovering Minsky

Published in Barron’s.

Hyman Minsky is featured in Randall W. Forsyth’s “Musk’s Buyout Plan May Signal Market Woes Ahead,”(Up & Down Wall Street, Aug. 11). About Hy, who was a good friend of mine and from whom I learned a lot, Forsyth says that his “insights were rediscovered after the financial crisis,” meaning the crisis of 2007-09. That is true, but Hy was previously rediscovered in the financial crises of the 1990s, and before that was discovered during the financial crises of the 1980s. The popularity of his ideas is a coincident indicator of financial stress.

Hy’s most important insight, in my opinion, is that the buildup of financial fragility is endogenous, arising from the intrinsic development of the financial system, not from some “shock” that comes from outside. I believe this key contribution to understanding credit cycles can be improved by adding that “the financial system” includes within itself all of the financial regulators, central banks, and governments. All are within the system; no one is outside it, looking down. They all are part of the endogenous process that generates the crises, which periodically cause Hy Minsky to be rediscovered again.
Alex J. Pollock
R Street Institute
Washington

Fixing capitalism

Published in Barron’s.

In “A Radical Proposal for Improving Capitalism” (Other Voices, June 16), Eric A. Posner and E. Glen Weyl repeat the venerable observation of Adolph Berle and Gardiner Means (in The Modern Corporation and Private Property, published in 1932) that in corporations, “ownership was separated from control,” where the shareholders are seen as principals and the management as hired agents. But this is old news.

The fundamental structure of corporations has changed little since 1932, but the structure of capital markets has changed a lot. In addition to the concentration of voting power that Posner and Weyl reasonably worry about, a more fundamental problem is that we now have an additional, dominating layer of agents: the investment managers. The result is a further separation: that of ownership from voting. The hired employees of the investment-management firms control the votes, and claim to be stockholders, but in fact they are merely agents with other people’s money.

What do those other people, the real owners, have to say in contrast to whatever their hired agents may think? Those may not be at all the same. If you don’t like agents being in control in the one case of separation, why would you like them being in control in the other?

Letter to Editor Barron’s: Listen up, Uncle Sam

Published in Barron’s.

Governments “should take particular care to prevent real estate bubbles,” writes Michael Heise (“Global Debt Is Heading Toward Dangerous Levels, Again,” Other Voices, May 19).

He’s right, of course. But the U.S. government does the opposite. As it has for decades, it promotes real estate debt and inflates real estate prices through government credit, subsidies, guarantees, and regulation—not to mention the massive monetization of mortgages by the Federal Reserve. When will they ever learn? The best bet is never.

Governments could take bitcoin out of circulation

Published in the Financial Times.

Nima Tabatabai asks about bitcoin, “can financial regulators control this emerging digital monetary asset?” ( Letters, May 18). The answer is they can. If a government sets its mind on it, it can tax, punish and regulate any monetary asset out of circulation. In the 1860s, Congress put a 10 percent tax on state bank notes to prevent their competing with the new U.S. national bank notes. State banks survived by expanding deposits, but state bank notes as a currency were gone. In the 1930s, the U.S. government, formerly on the gold standard itself, made it illegal for its citizens to own gold or denominate payments in it. Violating the prohibition was made a crime punishable by a fine of $10,000 or 10 years in prison. In the 1960s, the U.S. government simply refused to honor its explicit promise to redeem paper silver certificates with the silver dollars which were certified as “payable to the bearer on demand.” Thus U.S. dollar bills convertible to silver ceased to exist as a currency.

What might governments do to bitcoin or its holders or users? That depends on how threatened by it they feel.

EU could follow Lincoln’s model on dual banking

Published in the Financial Times.

Sir,

When looking at the difficulties of European banking union (“Eurozone banking union heads towards ‘critical phase’”, April 11), perhaps a model to explore is that created by the US during the administration of Abraham Lincoln.

The National Currency Act of 1863, now known as the National Banking Act, created banks chartered by the federal government. These new “national banks”, regulated by the national comptroller of the currency, existed and still exist alongside the “state banks” chartered by the individual US states. Thus we got the dual banking system.

Might the EU similarly think of a dual banking structure, with some banks chartered and regulated by the EU, and others remaining chartered by the individual member states?

Macroeconomics and the unknowable future

Published in the Financial Times.

Martin Wolf is so right that “a macroeconomics that does not include the possibility of crises misses the essential” (“Economics failed us before the global crisis,” March 21). Indeed, institutions, debt and the temptations of leverage are essential to the theory, especially leverage, which is the snake in the financial Garden of Eden. The expectations of the most rational, intelligent and well-informed people are often enough surprised and shocked by events. That the financial and economic future is not only unknown, but unknowable, is what an adequate macroeconomic theory must incorporate.

Skin in the student loan game

Published in Barron’s.

Sheila Bair (“Sheila Bair Sees the Seeds of Another Financial Crisis,” Interview, March 3) is so right about colleges having no skin in the troubled student loan game, which creates a fundamental misalignment of incentives. Colleges play a role like mortgage brokers did in the housing bubble: promoting the loans, getting the borrower to run up debt, and immediately benefiting financially from the loan but having zero economic interest in whether the loan defaults or not. Therefore, it has been too easy for colleges to inflate their costs into a bubble that floats on the government-sponsored debt, just as the bubble in house prices did. The solution is straightforward: Colleges should be fully on the hook for the first 20% of the student loan losses from each cohort of their students. This would make colleges care about their students’ future financial success, care about their defaults and losses, better control their costs, and in general create better outcomes for all concerned.

Housing bubbles always make mortgage books look good

Published in the Financial Times.

Thanks for Ben McLannahan’s very good Big Read survey of the house price and mortgage debt inflation in Canada (“Canada’s home loans crisis”, February 9). One point needs clarification, however.

Mr. McLannahan writes: “Many also note that mortgage books at the big banks look rock solid.” But this means little, for housing bubbles always make the credit performance of mortgage loans look good. As long as the borrowers can sell the houses for more than they paid, credit losses are minimal. As long as house prices keep rising, the lenders, like the borrowers, are happy. When the house prices ultimately fall, the defaults and losses appear and accelerate rapidly. The resulting contraction of credit makes them fall more.

It is the price of the house that is leveraged. The risk question is always: how much can prices fall? The answer is, more than you think.

The word ‘fintech’ is a contrast of two halves

Published in the Financial Times.

Sir, Your instructive report “Online lenders count cost of push for growth” (Dec. 15) recounts their rising defaults and credit losses. This points out the contrast between the two halves of “fintech” when it comes to innovation. The “tech” part can indeed create something technologically new. Alas, the “fin” part — lending people money in the hope that they will pay it back — is an old art, and one subject to smart people making mistakes. In finance, “innovation” can be just an optimistic name for lowering credit standards and increasing risk, with inevitable defaults and losses following in its train.

Central banks are useful but not that impressive

Published in the Financial Times.

Martin Wolf’s apologia for central banks (“Unusual times call for unusual strategies from central banks,” Nov. 13) asserts that critics of central bank financial manipulation assume that “in the absence of central bank policies, the economy would achieve an equilibrium.” As one such critic, I do not share the assumption claimed, since “equilibrium” in an innovative and enterprising economy never exists. As the great Joseph Schumpeter said: “Capitalism not only never is, but never can be, stationary.” It is always in disequilibrium, heading someplace else into an unknowable future.

Without doubt, central banks are very useful to finance panics and busts. They are also good at monetizing budget deficits to finance the government of which they are a part. Other than that, pace Mr. Wolf, their capabilities are not that impressive.

Economics and politics are always mixed together

Published in the Financial Times.

Sir, Mark Hudson (Letters, Oct. 3) is certainly correct that “economics is not a science.” Nothing could be clearer than that! But he exaggerates in asserting that economics is “a subsidiary branch of politics.” Rather, economics and politics are in actual experience always mixed together. The old term “political economy” captures the reality nicely.

Mr. Hudson is also right that the tenets of political economy are inevitably based on some psychological generalisation — going back to Chapter 2 of The Wealth of Nations and “a certain propensity in human nature . . . to truck, barter, and exchange.” For this propensity, we should be ever grateful.

Sovereign debt has a pretty poor record

Published in the Financial Times.

Sir, “Nations have historically been the world’s best credits,” says your report “Supranational debt issuance on a high” (Aug. 10). This sanguine view is contradicted by Lex in the same issue: “the ‘doom loop’ between sovereign bonds and banks … remains intact” (“Sovereign debt/banks: risk, waiting”). One of these statements must be wrong, and the wrong one is the former.

In fact, the history of sovereign debt is pretty poor. Carmen Reinhart and Kenneth Rogoff, in This Time is Different, count over the past two centuries 250 defaults on external sovereign debt, which have of course continued up to the present. Sovereign debt created a financial crisis in Europe in this century; in Russia, Asia and Mexico in the 1990s; and a global debt crisis in the 1980s. There were vast sovereign defaults in the 1930s.

Max Winkler, in his Foreign Bonds: An Autopsy, summed up the history as follows: “The history of government loans is really a history of government defaults.

Fed is far too dangerous to be unaccountable

Published in the Financial Times.

I would replace the headline of your editorial “An independent Fed had never been more crucial” (June 16) with a different thought: “Making the Fed accountable has never been more crucial.” The Federal Reserve is the most dangerous financial institution in the world, with an immense potential for disastrous mistakes. How can anyone believe that, as the discretionary manipulator of the world’s dominant fiat currency, it should be guided solely by the debatable and changing theories of a committee of economists? How can such a committee insist that it should be an independent power? Much wiser was former Fed chairman Marriner Eccles, the leader of the restructuring of the Fed in 1935, who referred to the Fed as “an agency of Congress.”

To qualify as an independent philosopher-king you have to be possessed of superior knowledge, but it is obvious that the Fed has none. It is equally as bad at forecasting the economic and financial future as everybody else. There is no evidence that it has any kind of superior insight. It does not know what the results of its own actions will be. That, combined with its capacity for damage, means it needs to be be made accountable in a system of governmental checks and balances, which is consistent with the American constitutional order.

The Fed needs to hold regular grown-up discussions with the Congress about what it thinks it is doing, what theories it is trying to apply, how its ideas are changing and which sectors are being hurt or helped by its actions. Your editorial worries about the effects of the politics such discussions might entail, but everything about the money question is, has been, and will be, political.

Colleges are acting like subprime loan brokers

Published in the Financial Times.

Rana Foroohar, in “Dangers of the college debt bubble,” points out a lot of problems with the U.S. student loan program, but misses the main point: the corruption of colleges by the flow of government money.

For a great many students, colleges play a role similar to that of a subprime mortgage broker: promoting risky loans with a high propensity to default. The college takes all the cash up front and spends it (perhaps, indeed, on “hiring more administrators” and “building expensive facilities”) and just like the subprime broker, it passes all the credit risk on to some sucker — in this case, the taxpayer.

An essential step to address this government-designed bubble is to make all colleges responsible for a significant part of the risk they promote and create. This is the lesson we thought we learnt from the housing bubble: give the pushers of credit some skin in the game. This might logically be done by making the colleges pay the first 20 percent of the loan losses of each student cohort.

I have come across one private college that has credit-enhanced the loans to its students under a fully private program for years, with excellent experience in terms of incentive alignment and financial results.

Do most colleges want to be responsible for their own risk-creating actions? Of course not. Should they be? Of course.

Barron’s LTE (Copy)

Published in Barron’s.

In asking “Is the Federal Reserve Using Overheated Data?” (Up & Down Wall Street, March 11), Randall W. Forsyth did the math: “If the Fed fulfills its own expectations of three [interest rate] hikes this year, it would put its target at 1.25 percent to 1.5 percent.” Let’s call it 1.5 percent at the end of this year. That is still a very low and substantially negative real interest rate. Against the Fed’s own goal of perpetual inflation at 2 percent a year, it is a real rate of negative 0.5 percent. Against the 2.5 percent increase in the consumer price index year over year through January 2017, it is a negative 1 percent real rate.

Although negative real interest rates during a crisis are usual, continuing them for nine years after the crisis ended, as it will be a year from now, serves powerfully to distort asset prices and rob savers.

Borrowers and speculators benefit at savers’ expense

Published in the Financial Times.

As your report “Fed balance sheet moves up agenda” makes clear (Jan. 19), the Federal Reserve’s quantitative easing experiment is still buying bonds and mortgage securities eight years after the crisis ended and five years after U.S. house prices bottomed. Why? What hath the Fed wrought?

It has helped out the government by seriously reducing the cost of financing federal deficits; it has allocated huge resources to its favoured uses of government spending and rapid inflation of house prices; and it has expropriated the wealth of savers by running years of negative real interest rates. Far from it being the case that “all boats were lifted,” I calculate, using long-run average real interest rates, that since 2008, the Fed has purloined about $2 trillion from conservative savers and given it to borrowers and leveraged speculators. The biggest borrower of all, and thus the biggest beneficiary, is of course the government itself, of which the Fed is such a useful part.

The Fed should be accountable for its results

Published in The Wall Street Journal.

“Vote Brings Uncertainty for Fed” (U.S. News, Nov. 10) says that President-elect Donald Trump might work with Congress to rewrite the laws governing the Fed’s structure. Good idea. It is of course decried by the Federal Reserve as a threat to its independence.

We should hope that the new president does proceed with this project. The Fed needs to be made accountable, as every part of the government should be. The notion that any part of the government, especially one as powerful and dangerous as the Fed, should be granted independence of checks and balances is misguided. Naturally, all bureaucrats resent being subject to the elected representatives of the people, but this doesn’t exempt them from their democratic accountability to the legislature that created them and may uncreate them.

The Fed is still carrying out emergency monetary experimentation seven years after the end of the crisis. It is busy robbing savers to benefit borrowers and leveraged speculators—a political act. It is imperative to figure out how best to make the Fed accountable to the Congress and to correct the evolved imbalance between its power and its accountability.

Chapter 11 for Social Security?

Published in Barron’s.

In their Other Voices essay, Dudley Kimball and Robert Morgan said that Social Security will be insolvent in 2034.

In the sense of having liabilities vastly greater than assets, it is deeply insolvent today. Social Security really needs the equivalent of a Chapter 11 bankruptcy reorganization.

Life expectancy for 20-year-old white men in the 1930s was 66—meaning that, on average, he’d get one year of Social Security. Today, a 20-year-old man has a life expectancy of 82.

Social Security has become a complex mix of financial functions. It is partly a welfare program; Kimball and Morgan would make it more so. It is partly a forced savings program with a very low average rate of return. It is partly insurance against outliving your savings. And it is entirely broke in present-value terms, reflecting cash already paid to those who took out much more than they put in.

It is time to draw a line and have a reorganization. Those people who can easily afford it could take substantial haircuts on their future benefits, receiving say 60 cents to 70 cents on the dollar, in exchange for voluntarily opting out of the program. This would make Social Security much less insolvent.

For the other creditors, Congress should step up, write off the Treasury’s loss, put in whatever it takes to pay off the accrued benefits at par, and put Social Security into runoff. To this extent, the government would then have honest, as opposed to dishonest, books. A program designed for the now-irrelevant demographics of the 1930s would slowly liquidate.

Then a sound retirement finance program could be put in place to go forward, based on 21st century demographics. Doubtless, the politics would be interesting. But perhaps starting over offers a better chance than trying to remake the 1930s DC-3 of Social Security into a jumbo jet while it’s flying.