"The excessive money creation by central
banks hold back economic recovery to take off", such a statement may look an
heresy considering that in western- and Japanese one - major central banks' intentions
the unprecedented money supply strong expansion from 2007-2008 financial crisis
should be intended to restore economic recovery vitality and stimulate credit supply
by the banking system. The point is, I think as several others, that central
banks reasoning and models fail on few key points so simple to be astonishing,
but as ancient chinese wisemen teach us: "The best place to hide something
is out in the open, in plain sight", as nobody ever thinks to look there.
Let me explain. Suppose you are an investor with substantial capital that we
can define real money (or saving) dealing with two alternatives: you can choose
between financial and productive investment or, better, between a
securities/equity portfolio purchase and a new production plant. Let's suppose
the decision will be taken on an expected return (yield) basis, or better on
the expected risk-adjusted return (yield), and we meet the first point where central
banks models seem to fail. Indeed, you do not need particularly advanced
mathematical knowledge to understand that any form of return, however small it
may be, "divided" by a risk parameter be zero or close to zero tends
to infinity. More, if you have a zero or close to zero interest rate either
your funding is cheap and a low but certain return is palatable and appealing.
Now if you are a central bank and you declare you're
ready to provide liquidity without limit and say that this liquidity is, and
will be, available at a rate close to zero or zero what else you affirm than that
financial risk is absent and the discount rate for the expected returns is near
or equal to zero? In such an environment when you invest in financial activity
you can always count on asset appreciation, as by definition monetary base will
be expanding quicker as economic growth get slower but, on the contrary, if you
invest in productive business as economic growth get slower it will be harder
to give back principal and interests you borrowed. So, the more you insist on
zero-interest rate and helicopter liquidity the more you divert real money from
productive investments to financial ones.
You can also find a parallel comparison with
liquidity trap. A liquidity trap is a situation, described in Keynesian
economics, in which injections of cash into the private banking system by a
central bank fail to lower interest rates and hence fail to stimulate economic
growth. A liquidity trap is caused when people hoard cash because they expect
an adverse event such as deflation, insufficient aggregate demand, or war.
Signature characteristics of a liquidity trap are short-term interest rates
that are near zero and fluctuations in the monetary base that fail to translate
into fluctuations in general price levels. If you consider, in a Tobin asset
theory perspective, that financial assets without risk are closer - as they
resemble more to- to liquidity and can be considered a semi-liquid or liquid
investment than you could explain why people prefer financial assets hoarding instead
of investing in productive activities and, so, why we observe asset inflation
and a relatively subdued consumer and industrial prices inflation. But now, how
can we exit this loop? Simple, it should be, as in chess game you must
sacrifice the tower to win the match: if you start a restrictive monetary
policy and let interest rates invert descending trend and getting higher the
risk premium on financial assets different from cash will grow. Then the
difference between financial and productive (or real) investment will shrink in
term of risk profile and investor will begin to diversify investing part of the
capital in productive activities and the other part in financial assets. In
short, you must accept to go worse before getting better. But this is a costly
and brave political solution often nobody want take until compelling
circumstances, system break-down, force them to take. "The Fed knows that
the U.S. economy is not recovering,” noted. “It simply is being kept from
collapse by artificially low interest rates and quantitative easing. As that
support goes, the economy will implode.” But as Weimar hyperinflation history
teaches us only stepping back to normal monetary policy solve the problem. Then
hyperinflation was in consumer and industrial prices now an excessive, probably
not "hyper", appreciation is in financial assets.
