Unintended Consequences of Easy Money

In response to the fall of Lehman Bros., almost fall of AIG and the financial crisis that this created Governments and Central Banks all over the World put the global economy into triage and slashed official interest rates, guaranteed their banking systems, guaranteed their banks and manned the fiscal pump. After a period of intense pressure and 6 months of concerns that the global economy was headed for a depression these policy measures combined with a pessimistic crescendo of selling into early March 2009 saw the equity market bounce and with it confidence, industrial production and the outlook for the economy.

This initial bounce seems to have run its course and Equities have struglled for 4 months now. So with the European periphery still struggling under the weight of Sovereign and Banking debts and with the US running a 40% chance of a double dip, according to Nouriel Roubini, we are concerned about both what governments and central bankers can do to further buttress their economies and financial systems and what the unintended consequences of the current policy settings may be longer term.

It is clear that low interest rates around the world are supposed to help kick start the economies by making it cheaper for companies to borrow to invest and, ultimately, to encourage savers to spend. But unintended consequences have throughout history often shown themselves to be more powerful than outcomes policy makers  were necessarily looking for. Milton Friedman and Anna Schwartz in their book "A Monetary History of the United States, 1867-1960" talk about the crime of 1873 when the price of silver was effectively pushed down relative to gold as setting the political climate all the way through the Presidential Election of 1900. Equally they suggest in "Money Mischief" that the US approach to Gold and Silver inadvertantly helped propel Mao and his long March to power over the top of Chiang Kai-shek.

We have already stated in the links section below we thing the Junk Bond rally a bubble of scary proportion and clearly an unintended new bubble consequnce of easy money.  So it is that the "Economist" Magazines Buttonwood column (cited in Interesting Links 20/9/2010 below) this week is running a story that the low interest rate environment globaly is  perhaps having some perverse impacts on behaviour. It says "Indeed, the rich world may be due for a cultural shift. If the motto of the past 25 years was “borrow now, pay later”, then “save now, rather than starve later” might soon be the more appropriate philosophy. Many people are unprepared for retirement. A staggering 47% of British women of working age do not have a pension plan, according to a survey by Baring Asset Management, and 22% of all adults aged between 55 and 64 are in the same position. If they think they will have a comfortable retirement on state benefits, they are in for a nasty surprise. Interest-rate cuts hurt savers’ incomes even as they make borrowers better off. If this income effect were to become powerful enough, it would be a nice irony. Low interest rates, which have the main aim of encouraging spending, could have the perverse effect of encouraging saving."

Once again it comes back to what is an increasingly astute analyis piece written by Andrew Haldane and referred to last week here. Patience forgone once shown to be illadviswed may indeed become simply patience delayed with consumers, investors and borrowers apt to seek to make up for lost time. we find it hard to understand how the so called advanced economies and their intellectual leaders missed the lesson of their poorer histories or of developing countries now. It is a lack of safety net that is often the reason for such a high level of savings in these developing economies. Once incomes rise to the level where government safety nets are provided and trusted consumption for every dollar of additional income can increase all other things equal.

The reverse must also be the case. Mustn't it? We believe that this is clearly analogous to the European debate about auterity. German policy makers or Northern Europeans more broadly, who we like to call austerians believe that austerity is good because by cutting services and deficits now pensions will be paid later so spending continues now. 

So as irrational as it may seem to "austerity your way to growth" we get the European idea. Kind of anyway. If consumers fret for their retirment incomes, savings and services the risk is that aggregate demand falls further. Either way when monetary policy loses traction the unintended consequence of trying to stimulate growth could be the reverse. To quote someone we read, apologies we can't remember who exactly but it could be Taleb, the longer this crisis goes on for the global economy then, quite possibly, we are further from the end not closer.