…inside the mind of a central banker. Very interesting stuff.
Let’s go step by step through this important interview.
SPIEGEL: Ms. Reinhart, central banks around the world are flooding the markets with cheap money in order to spur economies and support governments. Are these institutions losing their independence?
And here we come to our first objection: the premise of the question is wrong. Central banks are not “flooding the markets” with cheap money; what they have done so far is to shore up failed financial institutions through injection of reserves, which for the most part are just sitting there. Very important to understand this.
Anyway, her answer to the misleading question begins:
No central bank will admit it is keeping rates low to help governments out of their debt crises. But in fact they are bending over backwards to help governments to finance their deficits.
This is not puposely untruthful. Certainly, a primary beneficiary of a low interest environment is the borrower of last resort, which is the government, which when it swings into action in that role is a thing to behold. I mean look at US deficits over the last few years. But what is inadvertently revealing here is that in Carmen’s mind the government and the central bank are separate, and the central bank “helps” the government out of its “debt crisis”. Yet the central bank is a creature of government, created by statute. And it answers to the government. And it would not exist unless that were true. Carmen suffers from cognitive dissonance, at least a little, because in this whole area you have to get used to people talking out of both sides of their mouths. Especially central bankers.
And this particular central banker is perhaps more candid than she should be for her own good:
You have to deal with the debt overhang one way or the other because the high debt levels are an impediment to growth, they paralyze the financial system and the credit process. One way to cope with this is to write off part of the debt.
Discussion of debt write offs is off the table. Except around here.
Moving on, then:
But we are in an environment where politicians are very reluctant to do write-offs. So what happens is that money is transferred from savers to borrowers via negative interest rates.
She’s not even part right. It isn’t “money” that’s being transferred; it’s income. To a central banker the two are almost synonymous. That is a category error, I think. In any case, keeping interest rates artificially low might be bad for a lender’s income in theory, but generally isn’t in practice. Because as interest rates descend into the zero bound range “spreads” tend to increase in percentage terms. To illustrate, at 20% interest rates for savings I might be able to get away with lending at 25% or even 30%, making the spread between what is saved and what is lent 20-50%. But at 1% interest for savings I can still get away with lending at, say, 4% making the spread between what is saved and what is lent 300%.
See? A low interest rate environment might be terrible for savers, but it’s great for lenders.
SPIEGEL: Do you think it is wrong for Europe to focus on austerity measures with inflation at such a low level?
Reinhart: No. Restructuring, inflation und financial repression are not substitutes for austerity. All these measures reduce your existing stock of debt. Unless you do austerity you keep adding to the debt. There is no either-or. You need a combination of both to bring down debt to a sustainable level.
I think she’s misspeaking a bit here, but the core idea she is expressing is that “austerity” reduces the rate at which you add to the debt. I mean, it isn’t as if any sane person, and especially a central banker, would advocate an out and out reduction of debt, even by the government. That would be disastrous.
She’s a little clearer here:
SPIEGEL: So what should be done?
Reinhart: The best way of dealing with a debt overhang is to never get into one. Once you have one, what can you do? You can pray for higher growth, but good luck! Historically it doesn’t happen — you seldom just grow yourself out of debt. You need a combination of austerity, so that you don’t add further to the pile of debt, and higher inflation, which is effectively a subtle form of taxation …
There’s the prescription: Austerity plus “higher inflation”. Higher growth is impossible, she thinks. But of course she is egregiously wrong about that, although it would take another fairly long post to explain why.
But in any case, here’s the problem. “Austerity” means the government cuts back its spending; but to achieve “inflation”, there has to be new circulating money; and the central bank can essentially only funnel new money into the economy at this point through loans to the government, because private borrowers are tapped out and the government is effectively the only borrower left. And as regular readers over here should know by now, new money can only be borrowed into existence. There is (as a practical matter) no other way, the system does not permit any other way, and the “helicopter drop” allusion was meant as a joke precisely because the audience knew that new money can only be borrowed into existence, not dropped from helicopters.
So here is what the central bankers are doing about the “crisis”. They began by recapitalizing and further consolidating the “banking sector”, which had pretty much already become a creaking socialist boondoggle and now was transformed into a complete zombie 20th century artifact: not “failing” (dying) anymore since it is being propped up through literally trillions of dollars of “loans” – like keeping a dead person twitching with copious shots of adrenaline or something – but all that money just sits there because there’s no one to loan to.
This effort has failed and the central bankers know it. Nevertheless, the second phase of their “rescue” is to buy up huge amounts of government debt, the only rational purpose of which is for the government to spend the money into the economy so that we might see some”inflation”; but at the same time admonishing the government that it must not spend the money into the economy because unless we have “austerity” we’ll just keep “adding to the debt”.
This is incoherent, although it may have this one virtue: to stave off collapse of the financial system and governments for a little while longer than it would otherwise occur.
But here’s an interesting thought I had about all this. At least it’s interesting to me. The central bank is just a debt machine, and “debt” of course shares etymology with “death”. And having essentially given us a zombie banking system they are now proposing to give us zombie governments.
Somehow this – transforming our governing institutions into the collectivist equivalent of the undead – doesn’t seem like much of a solution to me. But this is where the economists are taking us. You heard it right from the horse’s mouth.
Update: One thing we can do, apparently, is
steal seize the gold from the relevant government when we’re not sure if the “austerity-inflation” prescription is working. Hmm. One question arising from this development is the degree to which the Eurocrats will resort to this option faster than the Fed, which after all still has “reserve currency” privileges. Not to mention, ultimately, the biggest stick.
Update 2: Here’s one potential consequence of the government becoming over-indebted: you have to start turning real estate over on the cheap to the daughters of foreign billionaires, just to keep the lights on. On the bright side, it will go well with their Easter bonnets.