14th October 2016
During six long years studying economics and quantitative finance, never once was the law of unintended consequences investigated with any great rigour. Market participants, it was assumed, were rational. Very rarely did we even examine economic theories from a cost/benefit perspective. Implicit in our analysis was that most convenient of phrases – ceteris parabis. It seems then that I left university with a degree in wishful thinking! Essential in all of this, was a focus on the short run. Many professors thought as John Maynard Keynes did, “in the long run we are all dead”.
The results of short term monetary experiments have left staggering costs, which may take generations to resolve. There is no question the cost of cheap long term money has created a debt mountain of epic proportions. The use of this debt over time has evolved, as if following Minsky’s theory to the letter. No longer utilised for investment reasons, debt is increasingly relied on to fund consumption or worse still to cover interest payments. While we have seen periodically large jumps in GDP, real productivity gains look to be behind us. Without productivity, the long run payoff to debt becomes smaller. As Irving Fisher said, debt is nothing more than future consumption today.
So what of today? Have we arrived at the long run? During September we witnessed what could be described as a pause in post 2008 monetary policy thinking. The scale and ultimate failure of the Bank of Japan’s policies serves as a stark warning to the rest of the world. All that is left in the armoury is rate fixing, which depending on circumstances could mean either more asset purchases or potentially tapering. For the ECB and the more hawkish Fed, the realisation that the costs of QE/negative rates have outweighed the ‘positive wealth effect’ is only now coming home to roost. Europe need not look any further than the state of its fragile banking system to understand these policies cannot continue indefinitely.
We have argued since the beginning of the year that policy makers will eventually recognise monetary policy is starting to impact the broader economy as well as social and political stability pretty hard. The Fed, ECB and BoE are desperately looking at their respective governments for assistance. We continue to believe in the old adage that a debt crisis turns into an economic crisis which turns into a social crisis until it becomes political. There are no economic solutions to today’s problems. The only solution will come from a change in the political status quo.
By Steven O’Hanlon