Mark W. Hendrickson
Mark W. Hendrickson is a faculty member, economist, and contributing scholar with the Center for Vision and Values at Grove City College, Grove City, Pennsylvania. These articles are from V & V, a web site of the Center for Vision & Value, and Forbes.com.
Negative Interest Rates: A Brilliant Concept!
I have to admit that initially I was uninterested, even close-minded, about the negative yield being offered on a growing share of European sovereign debt. "It must be a short-term aberration," I thought at first. "Completely nutso," I sniffed dismissively as the phenomenon spread. "Who in their right mind would invest in a financial instrument that would guarantee a loss of principal?" Upon calmer reflection, I would shrug and think, "Well, to each his own, but none of those topsy-turvy debt instruments for me."
More recently, I have taken a more tolerant attitude toward negative-yield debt. As I teach my Econ 101 students, the key to success in the economic marketplace is to set aside your own preconceptions and preferences and to acknowledge that the consumer is always right. If some of my fellow human beings want investment products that repay them less than their principal, who am I to find fault?
In fact, the more I think about it, I find myself attracted to the idea of offering such a service to satisfy this unfathomable consumer appetite for negative yields. Maybe I should announce that anybody out there who would like to send me money on the condition that I return less than all of it to them in the future is free to do so (as long as they include payment for any incidental transaction costs). From that perspective, negative interest rates are quite ingenious.
Actually, (I'm going to attempt to be serious now) what really got me thinking about the growing phenomenon of negative-yield debt was how to explain the concept to my 101 students. The traditional introduction to interest rates involves three basic components. The first is the "originary" rate of interest - the time preference between the present and the future. In years of teaching economics, I've never yet had a student express a preference for a hundred dollars next year over the same amount today, and I doubt I would get a different response if I lowered the payoff in the future to $99.90. Conclusion: The time preference of humans doesn't account for the increasingly common negative-yield phenomenon.
Perhaps, then, we can solve the mystery by examining the second component of interest rates - the risk factor. Students readily grasp the rationality of lenders adding a risk premium to interest rates to compensate for lending to higher-risk borrowers. Traditionally, the primary function of financial intermediation has been to assess the creditworthiness of borrowers. That isn't always the case at present, with government citing "disparate impact" and penalizing lenders who dare to consider risk before issuing loans. I can get my head around a risk premium of zero for government debt, since central banks can use QE and other techniques to ensure that governments have unlimited ability to return to its creditors however many monetary units it has borrowed. But a negative yield? One could certainly argue that nongovernmental borrowers, not having their own central banks, can't give 100 percent guarantees that they'll be able to repay what they borrow, while governments do; therefore, some creditors feel safer contracting for a negative yield from a government than a positive yield from a private entity. The problem with this line of thinking, though, is that creditors could lock cash in secure storage and know that they would get all of it back, rather than paying government to borrow their money.
The third component of interest rates is the inflation premium that creditors sometimes demand to protect against currency depreciation. The late Franz Pick used to call bonds "guaranteed certificates of confiscation" because, between depreciation of the monetary unit and government taxation of interest income, bondholders' purchasing power was systematically and ruthlessly transferred to government. Even today, in the bizarro world of central banks trying to "achieve" positive inflation (i.e., currency depreciation), one would think that creditors would insist on an inflation premium to offset the targeted depreciation. Instead, we have the spectacle of widespread acceptance of a nominally negative return on paper denominated in a currency that the relevant central bank is actively trying to depreciate.
In sum, elementary interest rate theory doesn't solve the puzzle of why there are negative-yield instruments, so we need to look elsewhere. Perhaps the holders of negative-yield sovereign debt instruments anticipate earning capital gains due to increased demand for negative-yield securities in the future. This seems like a bet on the "greater fool theory" with central banks playing the part of the "fool." I suppose it's possible that in our strange new world of unlimited QE, chronic ZIRP, negative interest rates, etc., yields may become even more negative in the future, thereby rewarding those who solved earliest this counterintuitive riddle. Such a race deeper into the rabbit hole of negative yields may happen, but timid (blind?) little me won't be on the buy side of those deals.
One other possible explanation for the phenomenon of negative interest rates is that central banks are trying to make their currency less attractive in currency exchanges. This is what makes the most sense to me - central bankers hope that negative interest rates will be an effective tool of currency manipulation in a world of competitive devaluations.
Negative interest rates are a weird and alarming symptom of profound economic dysfunction. In a healthy economy, interest rates coordinate production between the present and the future according to people's composite time preferences. Today, those vitally important market signals are mangled, broken, shattered. Maybe negative-yield instruments will pay off in ways I don't yet perceive, but I'm content to keep my distance from them and let others play that bizarre game. I'd rather preserve my sanity.
Nobel Economist Joseph Stiglitz Misdiagnoses Inequality and the Cause of Middle Class Woes
In an interview posted on Yahoo.com, Nobel Prize-winning economist Joseph Stiglitz spoke about growing economic inequality and America's shrinking middle class. Agreed, these are challenging and discouraging times for many, but as has happened before, Mr. Stiglitz provides a faulty explanation.
Stiglitz spoke fondly of the highly progressive tax code and lesser degree of inequality that followed World War II. Like his intellectual comrade, Thomas Piketty, he looks more favorably upon the Great Depression, with its greater poverty but lower measures of inequality, than the 1980s, with its significant improvements in standards of living for the non-rich accompanied by higher measures of inequality.
Stiglitz veers into historical revisionism by asserting that today's inequalities originated during the Reagan years with its supply-side tax cuts that made the tax code less progressive and allegedly benefited only the rich. I would counter that there is a much more obvious cause for today's sluggish economic growth and concomitant middle class struggles: Growth in government.
Stiglitz and I agree that standards of living improved after the end of World War II. He, though, implies that this prosperity was due to the more egalitarian progressive tax code of the era, with its top marginal rate of 91 percent. I know of no accepted economic theory that high taxes create prosperity. The real explanation for the post-war boom was that after years of suppressed consumer spending enforced by wartime rationing and the diversion of resources to the war effort, peacetime released a flood of pent-up demand as Americans made up for lost time. The huge decline in federal spending after the war (from 48 percent of GDP during the war down to 15 percent in the late '40s) released billions of dollars to the private sector which turbo-boosted a strong economic recovery.
Economic growth was more tepid in the 1950s. There were three mild recessions during the Eisenhower years, helping to tip the 1960 election to the Democrats. President Kennedy's bequest to the American people was a tax cut that boosted economic growth in the mid-'60s.
The foundation for today's malaise was laid in the mid-'60s when Lyndon Johnson significantly expanded the federal government by waging two expensive wars - the War on Poverty and the Vietnam War - while adding new federal entitlements (Medicare and Medicaid). Richard Nixon and Gerald Ford continued the spending binge, with an early casualty being the dollar's gold backing, followed by rampant inflation and rising unemployment that made the 1970s a lost decade economically for many Americans.
The economic stagflation of the 1970s was routed during Reagan's presidency. His supply-side policies revived economic growth. For Stiglitz to claim that only the rich benefited from Reagan's policies is egregiously contra-factual. The poverty rate fell and median incomes and net worth rose. The Reagan recovery (which carried on through the Clinton years with only mild pauses) was a boon to the American people. That being said, the failure of Reagan and the Democratic congress to halt the growth of government and to confine their spending to match government's tax revenue deserve a share of the blame for our sluggish economy today.
Deficit spending took a welcome breather under President Clinton and a Republican House under Newt Gingrich, but the regulatory state continued to expand its growth-restricting reach on the economy. Then, during the economically disastrous presidencies of George W. Bush and Barack Obama, massive spending (much of it in response to the fallout from the government/Fed-engineered housing bubble and subsequent Wall Street bailout) and increasingly active regulatory agendas have diminished economic growth, thus reducing opportunities for the non-rich to make economic progress.
So here we are today, suffering a record-slow post-recession recovery resulting in fewer opportunities for economic advancement for non-rich Americans. Big Government produced an $18-trillion debt that has impelled the Federal Reserve to suppress interest rates, thereby delaying the needed adjustment of ending the fiscal malpractice of government over-spending and distorting capital markets. This, combined with a suffocating regulatory regime that wars against business has put us in the unusual and worrisome situation of businesses closing at a faster rate than new businesses are opening, thereby shrinking employment opportunities.
The cause of the current economic sluggishness that is "hollowing out" the middle class is Big Government. Repeated economic studies, such as the ones I cited in my book cataloging the errors in Thomas Piketty's book on inequality, show the negative correlation between government spending and economic growth. Additional evidence is found in the Heritage Foundation's Index of Economic Freedom, which shows that as Big Government has made our economy less free, growth has slowed.
Joseph Stiglitz's diagnosis is flat-out wrong when he argues that the middle class is declining because the rich are getting richer. That zero-sum view is atavistic mercantilist nonsense. In a free market, transactions are positive sum, so individuals become wealthy in return for economically benefiting others. It is in the political marketplace where transactions are zero-sum - where wealth that benefits some comes at the expense of others. Indeed, we have a lot of that today in the form of bailouts, subsidies, boondoggles, and other forms of cronyism. If Mr. Stiglitz would oppose those growth-sapping cancers, I'd gladly make common cause with him, but for him to blame the rich instead of government for today's problems reflects a partisan and ideological bias rather than objective economic analysis.
Because Stiglitz's diagnosis is wrong, his prescription also is wrong. Raising taxes on the rich won't improve the economic prospects of the non-rich. Shrinking the burden of government will.
Free to Speak His Own Mind, Ben Bernanke Shows Himself to Be an Unreconstructed Orthodox Keynesian
As those familiar with my writing know, I was never a fan of erstwhile Federal Reserve Chairman Ben Bernanke. Indeed, while some praised him as "the greatest central banker in U.S. history," I thought otherwise.
In trying to give Bernanke every benefit of the doubt, I have wondered whether some of the pernicious policies he adopted at the Fed were not the result of his own economic convictions, but instead were forced on him by intense political pressures. Surely, I thought, no economist could really believe that creating money produces prosperity or that suppressing the pricing mechanism that coordinates present with future economic activity (i.e., interest rates) is prudent. Alas, it appears I was wrong.
Now that he is a private citizen again, I have wondered whether Bernanke might change his tune. In a word, "no." Recently, an entry from Bernanke's new blog found its way into my inbox. In this blog post, Bernanke dispensed advice to Germany that was unimaginative, unadulterated Keynesian orthodoxy - a flawed theoretical paradigm with a dismal track record. Tragically, the ghost of Keynes still haunts us today.
In writing about Germany's trade situation, Bernanke casts the problem in Keynesian terms, asserting that there is insufficient "aggregate demand" today. According to this view, the problem is that people aren't spending enough on consumption. Shame on them! Therefore, it's up to the government to correct this mistake. Here we see the close similarity between macro-economic policy prescriptions and socialist central plans: In both cases, the elite planners act like puppeteers, trying to pull the strings to make people do what the planners think they should be doing - as if they know better than the people what the people want or should want to consume.
In the macro paradigm that Keynes devised, the micro perspective of acting and choosing individual human beings is lost. For macro strategists to assert that a population is making a collective mistake in how much they demand ignores the fact that all of the individuals comprising the collective are making the right decisions for themselves. Who is Bernanke or any other economist to claim that they aren't spending enough? There are many valid micro-economic explanations for why individuals and businesses limit their spending: Perhaps they simply don't need or want any more of certain products; perhaps they would purchase more if prices were lower; perhaps they are burdened by debt from previous expenditures; perhaps they prefer to save some of their income for future instead of present consumption. Whatever the reason(s), markets will communicate the necessary price information to reshape economic production to align more closely to people's preferences - or at least they will if public officials don't intervene and falsify those signals through fiscal or monetary policy. Those in power do not know how much demand there "should be" in specific markets, and government attempts to "correct" market behavior is counterproductive economic quackery.
In his blog post, Bernanke makes several specific recommendations to Germany:
First, he says that spending more money to improve Germany's transportation infrastructure would "increas[e] domestic income and spending, while also raising employment and wages." Has Bernanke so soon forgotten President Obama's 2009 non-stimulating "stimulus plan," under which a massive increase in infrastructure spending produced no uptick in economic growth and employment? Government spending does not increase wealth, but merely redirects it. Jobs created by government spending are offset by an equal or larger number of jobs that cease to exist or do not get off the launching pad when scarce economic resources are diverted from the private sector to additional public-sector activity (Bastiat's lesson about "the things not seen").
Second, Bernanke writes, "German workers deserve a substantial raise, and the cooperation of government, employers, and unions could give them one." This is a normative statement, a personal opinion, not a specimen of economic analysis. Whether German workers deserve or should get a raise is a matter for markets to determine, not some economist. Surely, Bernanke knows that wages are a price phenomenon and that artificially raising wages above the market-clearing price is a formula for higher unemployment. Do some German workers "deserve" to lose their jobs?
Third, Bernanke recommends that Germany's government facilitate increased spending through targeted "tax incentives for private domestic investment; the removal of barriers to new housing construction; . . . and a review of financial regulations that may bias German banks to invest abroad rather than at home." Here, I see a glimmer of hope that Bernanke is not so completely in thrall to Keynesian mysticism, for he recognizes the importance of incentives to individual economic actors. However, he still has the state's role backward. The first rule of the economics profession should be the same as it is in the medical profession: first do no harm - in other words, before even trying to do something beneficial, make sure you're not doing something harmful. Thus, rather than advocating targeted tax incentives to promote desired actions, the correct recommendation would be to remove existing disincentives (taxes, etc.) that impede investment.
For the rest of this wish list, though, Bernanke is on target when he recommends removing the political shackles that limit and hamstring economic activity. Government intervention - whether in the form of taxes, spending, regulation, or monetary manipulations - warps market signals and thus distorts economic decision-making. What Germany needs, as Bernanke implies in his third recommendation, is less government interference with markets.
The problem, though, is that by viewing the situation through a Keynesian macro-economic lens, Bernanke wants to pick and choose which markets to liberate from stifling government restrictions - there is the puppeteer mentality again. The true path to prosperity is for all markets to be liberated from the quack tinkering of master planners and be allowed to develop freely within the context of the rule of law. Maybe Ben Bernanke will arrive at that conclusion some day. Until then, we can be glad that he isn't in a position of power any longer and that, for the moment at least, we here in the States aren't the target of his flawed Keynesian advice. *
