Stuck in the 20th Century
By Staff News & Analysis - April 10, 2013

The low-rate world was not meant to last. The Federal Reserve is making a better job of it than the European Central Bank … In 2008-09, when central banks slashed short-term rates close to zero and started buying bonds to push down longer-term rates, everyone assumed these extraordinary measures would soon be unwound as economies recovered. But the extraordinary has become the norm. America's Federal Reserve is still printing money to buy bonds and has made it clear that it will not raise short-term rates at least until unemployment, now close to 8%, falls to 6.5%. – The Economist

Dominant Social Theme: The Fed knows what it is doing.

Free-Market Analysis: This Economist article actually maintains that the Federal Reserve is doing a better job of making a US recovery happen than the ECB.

Economist writers and editors ought to visit the United States to see how the recovery is actually going. Many parts of the United States are rundown, with houses shuttered and businesses closed, especially in the so-called red states of the Midwest.

What money printing – The Economist's favorite prescription – does is expand bank balances and boost corporate balance sheets as well, because the money is not flowing into the "real" economy but only into the economy influenced by the central bank.

In a modern Keynesian-based reflation, stock markets go up and pull along the largest economic participants with theme – usually multinationals, etc. But this benefits only a small portion of the larger economy and actually expands business without clearing away previous distortions. The Economist is apparently okay with this sort of expansion. Here is more from the article:

… The Bank of England's mandate has been tweaked to allow rates to stay lower longer. Even the European Central Bank (ECB) may be inching towards greater boldness. The message from the rich world's central banks is clear: the era of ultra-loose monetary policy is here to stay.

That has had a huge effect on financial markets. Japan's Nikkei index is up by 40% since Mr Abe promised bold stimulus in November. America's S&P 500 index and the Dow Jones industrial average are both at record levels. Frothiness is back as investors search for higher returns, whether in junk bonds, African government debt or the new "structured credit" products dreamt up by the same investment banks that sliced up mortgages in the bubble years (see article).

Unfortunately, the effect on output has been more muted. America's GDP is showing signs of accelerating. But Europe's economies are flat or shrinking. Overall, rich-world growth is likely to be barely over 1% in 2013, little better than in 2012.

Given the gap between financial froth and feeble growth, are central bankers doing the right thing? Supporters argue that cheap money is essential for economic recovery, particularly when (as in Europe and America) austerity-minded governments are tightening fiscal policy. Critics counter that low rates simply pump up asset bubbles, distort financial markets and risk inflation. The Economist is a supporter—but cheap money will work only if the medicine is administered properly and if governments change other things, too.

… The link that has proved most elusive is between cheap money and corporate investment. Firms have taken advantage of the low rates to issue new debt, but they have used the cash to refinance loans or build up rainy-day funds. That may make sense for the firms concerned, but it provides a smaller boost to growth than building new factories. Businesses are still sitting on record piles of cash ($1.8 trillion in America's listed firms alone). High share prices and low borrowing costs should eventually awaken bosses' animal spirits. In America capital spending is accelerating. In Europe the prospects are gloomy, not only because of worries about the euro and growth but also because cheap money is regional: according to Goldman Sachs, rates for business loans in southern Europe are nearly four percentage points higher than in the north.

We can see from the last paragraph here that The Economist is firmly linking the recovery to the stock market and "high share prices." Of course, high share prices are a product of money printing and, again, this is an entirely artificial way of boosting an economy that does nothing to reduce or remove previous monetary distortions.

The Economist goes on to suggest that there are three ways Europe can "learn from America." First, it is good to be bold, The Economist tells us. Apparently, The Economist approves of the tens of trillions that Ben Bernanke has printed.

Second, Bernanke's focus on buying mortgage-backed bonds is more stimulative than the purchase of government bonds. Finally, the US has restructured banks faster than Britain and the EU. This has also contributed to a US resurgence.

We, of course, would humbly disagree with every one of these assessments. An economy is the sum total of its parts and not merely a balloon that can be inflated by monetary stimulation. This idea that one can "manage" one's way to a sound economy should have been disproven by now, given all the Keynesian disasters that have occurred.

But this is the narrative, nonetheless, that The Economist wants to suggest. Aggressive money printing is preferable to "timidity."

Gee, here is our thought: Such an explanation worked better in the 20th century when people didn't really understand about monetary theory and had no access to the Internet and articles and websites that could explain it to them.

In the 21st century, given all the experiences of the West with boom-and-bust monetary cycles, such nostrums are likely a lot harder to peddle.

After Thoughts

This article, we would submit, is stuck in the 20th century – along with The Economist itself.