Ludwig von Mises Institute
The ECB is now two months into its bond buying binge but the European Central Bank (ECB) never clearly explained the goal and purpose of its own version of quantitative easing. The deflation bogeyman was never a serious threat, nor was it based on any solid theoretical foundation.A possible justification may have been to make the 1 percent much wealthier so that their extravagant lifestyles trickled benefits down to the average working stiff. Another possible reason may have been to lower the value of the euro to benefit exporters at the expense of the rest of European consumers, the middle class, and the poor. This would be a violation of the unwritten rule that monetary policy should not be targeting the value of the currency directly.Of course, when the rule maker breaks his own rules, it reduces the importance of all rules. The commitment not to print to finance government spending has gone to the same graveyard as the 60 percent debt-to-GDP rule or the under-3 percent budget deficit rule. Meanwhile, the ECB’s current actions are making a mockery of the alleged independence of central banking.Central Banks Are Buying Up Government DebtUnder normal conditions, economists take it for granted that interest rates cannot drop below zero. Instead of paying someone to borrow your money, you could just as easily stuff the money in your mattress. So why is so much of European government debt actively trading at negative rates? Why would you take money out of your mattress and pay 1,060 euros for something that will only get 1,000 euros in a year?The answer is simple: buying government debt can make sense if you have no intention of holding the debt to maturity and think you can find a “greater fool” who will buy the debt from you. That greater fool is often the European Central Bank which, like many other central banks around the globe, is buying up government debt to keep debt-financed programs alive for another day.And now, faced with very low or even negative interest rates on government debt, governments have been rushing to issue even more debt before announcing, in all likelihood, more vote-getting government expenditures. So, let’s not be fooled by the ECB’s charade that its actions are not indirectly financing new government expenditures.Why Aren’t Banks Lending More?What about bank lending? Isn’t the ECB’s quantitative easing and negative-interest-rate policy spurring a Europe wide surge in borrowing? After all, negative interest rates are supposed to have the effect of discouraging saving and encouraging movement away from presumably safe government debt into other types of borrowing.You can lead a horse to water, but you cannot make him drink, so the fact that interest rates are at rock bottom levels is not necessarily enough to spur a frenzy of borrowing by businesses in the face of an uncertain economic future.Banks also face new hurdles. Not surprisingly, the ECB’s current actions are, in reality, being somewhat defeated by its previous monetary policy. Banks, as financial intermediaries, make money between deposit rates and lending rates. They borrow short term and lend long term.By setting negative rates on reserves, however, and by inducing negative interest rates on government bonds, the ECB has created a significant compression in yields. This has reduced bank profits. Banks must now charge customers for deposits. Large customers such as hedge funds and mutual funds have been withdrawing funds, further drawing down bank profits.For example, several large pension funds in Switzerland have recently rediscovered the advantages of the mattress. As Pater Tenebrarum noted,One fund manager showed that for every CHF 10 million in pension money, his fund would save CHF 25,000 — in spite of the costs involved in vault rent, cash transportation and other expenses.Furthermore, Basel III forces banks to hold more risk-free assets. Banks have been forced to load up on government debt at negative rates. This also has been squeezing profits. Does anyone really expect European banks to lend more in such an economic environment?What’s the Endgame?The real objective of the ECB’s current money printing is essentially to kick the can down the road. It won’t solve Europe’s deep-seated structural problems. It will only postpone the inevitable and will also make the final reckoning much, much worse. Printing intrinsically worthless paper will not solve Europe’s fundamental problem of supply being misaligned with demand — a misalignment created by government’s incessant interference with the workings of the price system.With this new phase of monetary expansion, Europe is slowly walking down the same slippery slope toward hyperinflation that is the inevitable endgame of all fiat currency systems.In this, Germany missed an opportunity to set the ship straight. It should have made it crystal clear that any purchase of government bonds by the ECB (which violates European law) would have meant Germany’s leaving the currency union and reestablishing the deutschmark under German control. But then again, the German government is not the German people. Such quantitative easing makes it much easier to finance government spending, and the resulting inflation will lower the real value of the government’s existing debt. Of course, this is all for short-term benefits to the government, with long-term costs to everyone else.
Argentina will hold elections this year, and a number of provinces will be electing governors. Buenos Aires, the capital city, is holding elections for mayor, and Mauricio Macri, who is stepping down as mayor, is a favorite to become the next president. Toward the end of the year, a presidential election will be held and Cristina Kirchner, after two consecutive mandates, will have to step down because she cannot be re-elected.Like Chávez and Maduro in Venezuela, Argentina can be described as a country that fell victim to extreme populism during the Nestor and Cristina Kirchner administrations, which began in 2003. Twelve years later, this populist political project is about to end.The economic policy of populism is characterized by massive intervention, high consumption (and low investment), and government deficits. This is unsustainable and we can identify several stages as it moves toward its inevitable economic failure. The last decade of extreme populism in Argentina can be described as following just such a pattern.After observing the populist experience in several Latin American countries, Rudiger Dornbusch and Sebastián Edwards identified four universal stages inherent in populism in their article “Macroeconomic Populism” (1990). Even though populism can present a wide array of policies, certain characteristics seem to be present in most of the cases.Populism usually fosters social mobilization, political propaganda, and the use of symbols and marketing practices designed to appeal to voter’s sentiments. Populism is especially aimed at those with low income, even if the ruling party cannot explain the source of its leaders’ high income. Populist rulers find it easy to use scapegoats and conspiracy theories to explain why the country is going through a hard time, while at the same time present themselves as the saviors of the nation. It is not surprising that for some, populism is associated with the left and socialist movements, and by others with the right and fascist policies.The four stages of populism identified by Dornbusch and Edwards are:Stage IThe populist diagnosis of what is wrong with an economy is confirmed during the first years of the new government. Macroeconomic policy shows good results like growing GDP, a reduction in unemployment, increase in real wages, etc. Because of output gaps, imports paid with central bank reserves, and regulations (maximum prices coupled with subsidies to the firms), inflation is mostly under control.Stage IIBottleneck effects start to appear because the populist policies have emphasized consumption over investment, the use of reserves to pay for imports, and the consumption of capital stock. Changes in sensitive relative prices start to become necessary, and this often leads to a devaluation of the exchange rate, price changes in utilities (usually through regulation), and the imposition of capital controls. Government tries, but fails, to control government spending and budget deficits.The underground economy starts to increase as the fiscal deficit worsens because the cost of the promised subsidies need to keep up with a now-rising inflation. Fiscal reforms are necessary, but avoided by the populist government because they go against the government’s own rhetoric and core base of support.Stage IIIShortage problems become significant, inflation accelerates, and because the nominal exchange rate did not keep pace with inflation, there is an outflow of capital (reserves). High inflation pushes the economy to a de-monetization. The local currency is used only for domestic transactions, but people save in US dollars.The fall in economic activity negatively affects tax receipts increasing the deficit even more. The government needs to cut subsidies and increases the rate of the exchange rate, depreciation. Real income starts to fall and signs of political and social instability start to appear. At this point the failure of the populist project becomes apparent.Stage IVA new government is swept into office and is forced to engage in “orthodox” adjustments, possibly under the supervision of the IMF or an international organization that provides the funds required to go through policy reforms. Because capital has been consumed and destroyed, real wages fall to levels even lower than those that existed at the beginning of the populist government’s election. The “orthodox” government is then responsible for picking up the pieces and covering the costs of failed policies left from the previous populist regime. The populists are gone, but the ravages of their policies continue to manifest themselves. In Argentina the expression “economic bomb” is used to describe the economic imbalances that government leaves for the next one.Economic Populism is Alive and WellEven though Dornbusch and Edwards wrote their article in 1990, the similarities to the situation in countries like Venezuela, Bolivia, and Argentina is notable. In recent years, to keep populist ideas going in the minds of voters, Venezuela created the Ministry of Happiness, and Argentina created a new Secretary of National Thought.These four stages are actually cyclical. The populist movement uses the fourth stage to criticize the orthodox party, and argues that during the populists’ tenure, things were better. The public opinion discontent with stage IV allows the populist movement to win new elections, receive an economy in a crisis or recession and the cycle starts over again from stage I. It is not surprising that populist governments usually appear following the hard times caused by economic crisis. A more bold populist government could avoid stage IV by finding a way to remain in office, calling off elections, or creating fake election results (as was the case in Venezuela). At such a point, the populist government succeeds in turning the country into a fully authoritarian nation.
In recent years, home price indices have seemed to proliferate. Case-Shiller, of course, has been around for a long time, but over the past decade, additional measures have been marketed aggressively by Trulia, CoreLogic, and Zillow, just to name a few.Measuring home prices has taken on an urgency beyond the real estate industry because for many, home price growth has become something of an indicator of the economy as a whole. If home prices are going up, it is assumed, “the economy” must be doing well. Indeed, we are encouraged to relax when home prices are increasing or holding steady, and we’re supposed to become concerned if home prices are going down.This is a rather odd way of looking at the price of a basic necessity. If the price of food were going upward at the rate of 7 or 8 percent each year (as has been the case with houses in many markets in recent years) would we all be patting ourselves on the back and telling ourselves how wonderful economic conditions are? Or would we be rightly concerned if incomes were not also going up at a similar rate? Would we do the same with shoes and clothing? How about with education?With housing, though, increases in prices are to be lauded, we are told, even if they outpace wage growth.We’re Told to Want High Home PricesBut in today’s economy, if home prices are outpacing wage growth, then housing is becoming less affordable. This is grudgingly admitted even by the supporters of ginning up home prices, but the affordability of housing takes a back seat to the insistence that home prices be preserved at all costs.Behind all of this is the philosophy that even if the home-price/household-income relationship gets out of whack, most problems will nevertheless be solved if we can just get people into a house. Once someone becomes a homeowner, the theory goes, he’ll be sitting on a huge asset that (almost) always goes up in price, meaning that any homeowner will increase in net worth as the equity in his home increases.Then, the homeowner can use that equity to buy furniture, appliances, and a host of other consumer goods. With all that consumer spending, the economy takes off and we all win. Rising home prices are just a bump in the road, we are told, because if we can just get everyone into a home, the overall benefit to the economy will be immense.Making Homes Affordable with More Cheap DebtNot surprisingly, we find a sort of crude Keynesianism behind this philosophy. In this way of thinking, the point of homeownership is not to have shelter, but to acquire something that will encourage more consumer spending. In other words, the purpose of homeownership is to increase aggregate demand. The fact that you can live in the house is just a fringe benefit. This macro-obsession is part of the reason why the government has pushed homeownership so aggressively in recent decades.The fly in the ointment, of course, is if home prices keep going up faster than wages — ceteris paribus — fewer people will be able to save enough money to come up with either the full amount or even a sizable down payment on a loan.Not to worry, the experts tell us. We’ll just make it easier, with the help of inflationary fiat money, to get an enormous loan that will allow you to buy a house. Thus, rock-bottom interest rates and low down payments have been the name of the game since the late 1980s.We started to see the end game at work during the last housing bubble when Fannie Mae introduced the 40-year mortgage in 2005, which just emphasized that when it comes to being a homeowner, the idea is not to pay off the mortgage, but to “buy” a house and just pay the monthly payment until one moves to another house and gets a new thirty- or forty-year loan.It Pays To Be in DebtOn the surface of it, it’s hard to see how this scenario is fundamentally different from just paying rent every month. If the homeowner stops paying the monthly payment, he’s out on the street, and the bank keeps the house, which is very similar to the scenario in which a renter stops paying a landlord. There’s (at least) one big difference here, however. It makes sense for the homeowner to get a home loan rather than rent an apartment because — if it’s a fixed-rate loan — price inflation ensures the real monthly payment will go down every month. Residential rents, on the other hand, tend to keep up with inflation.But why would any lending institution make these sorts of long-term loans if the payment in real terms keeps getting smaller? After all, thirty years is a long time for something to go wrong.Lenders are willing and able to do this because the loans are subsidized and underwritten through government creations like Fannie Mae (which buys up these loans on the secondary market), through bailouts, and through a myriad of other federal programs such as FHA. Naturally, in an unhampered market, a loan of such a long term would require high interest rates to cover the risk. But, Congress and the Fed have come to the rescue with promises of bailouts and easy money, meaning cheap thirty-year loans continue to live on.So, what we end up with is a complex system of subsidies and favoritism on the part of lenders, homeowners, government agencies, and the Fed. The price of homes keeps going up, increasing the net worth of homeowners, and banks can make long-term loans on fairly risky terms because they know bailouts of various sorts will come if things go wrong.But problems begin to arise when increases in home prices begin to outpace access to easy money and cheap loans. Indeed, we’re now seeing that homeownership rates are going down in spite of low interest rates, and vacancy rates in rental housing are at a twenty-year low. Meanwhile, new production in housing units is at 1992 levels, offering little relief from rising prices and rents. Obviously, something isn’t going according to plan.Who Loses?The old debt-based tricks that once kept homeownership climbing and accessible in the face of rising home prices are no longer working.From a free market’s perspective, renting a home is neither good nor bad, but American policymakers long ago decided to favor homeowners over renters. Consequently, we’re faced with an economic system that pushes renters toward homeownership — price inflation and the tax code punishes renters more than owners — while simultaneously pushing home prices higher and higher.During the last housing bubble, however, as homeownership levels climbed, few noticed or cared about this. So many renters became homeowners that rental vacancies climbed to record highs from 2004 to 2009. But in our current economy, one cannot avoid rising rents or hedge against inflation by easily leaving rental housing behind.This time around, the cost of purchasing housing is going up by 6 to 10 percent per year, but few renters can join the ranks of the homeowners to enjoy the windfall. Instead, they just face record-high rent increases and a record-low inventory in for-sale houses.There once was a time when rising home prices and rising homeownership rates could happen at the same time; it was possible for the government to stick to its unofficial policy of propping up home prices while also claiming to be pushing homeownership. We no longer live in such a time.
[Excerpted from March/April 2015 issue of The Austrian.]THE AUSTRIAN: How did you first become familiar with the Mises Institute?Jingjing Wang: I do not remember the exact time when I first got to know the Mises Institute, but I heard Hayek’s name around 2007 when I was a junior student in business administration in China. It was 2010, when I took a course in Beijing on “Classical Readings in Institutional Economics” for my master’s degree. Ludwig von Mises’s book Liberalism was on the reading list. I did web searches on Mises, and found there was an institute named after him. I became more and more familiar with the Mises Institute after 2011 when I came to the US for Ph.D. study.TA: In recent years, we’ve seen more and more activity from Austrian scholars and translators in China. What’s your assessment of the state of Austrian economics and free-market economics in general in China?JW: It is very inspiring that there are more and more academic activities by Austrian scholars and similarly minded people. These activities include translating classical books, organizing seminars and reading groups, and even publishing original works related to Austrian economics. But research by Chinese scholars on Austrian economics is not a totally new phenomenon.For instance, Böhm-Bawerk’s works were translated into Chinese as early as the 1930s. Hayek also had a few Chinese students when he taught at the London School of Economics, and his disciples brought Austrian economics back to mainland China through Taiwan or Hong Kong. In recent years, due to the influence of the internet and the enthusiasm of young students, translations are not limited to classical books. More and more, recent Mises University videos, Mises Daily articles, and interesting topics from other sources have also been translated, and these can reach a much broader audience than traditional channels. So, I am very positive about this movement. In the future, I hope all these works can lay a very solid foundation for other scholars to conduct original studies, and for applied Austrian economics to analyze what has happened in China.TA: Why did you decide to pursue an academic career?JW: That is a hard question to answer. Actually, I never thought to pursue an academic career initially since I did not know what it meant before I went to the university. Also, I did not expect I could get a chance to go to study in the university, although I had a dream to be an elementary or middle school teacher when I was young. Later, after I chose business administration as my major by accident, I thought that being a white collar worker and earning decent money is also a good choice. But, I felt lost after years of being a star student and learning things which I was not very interested in. In my senior year, following my advisor Xiaoyun Yang’s advice, I wandered around neighboring universities, auditing courses randomly, and searched topics which I have passion for. She was my first mentor who led me to doing serious research. Then, I followed my heart and ended up pursuing an academic career. I think it is the place where I can find a peaceful mind, a happy and meaningful life.TA: What convinced you to apply to become a Mises Institute Fellow?JW: The real question is about what motivated me to do what it took to become a Mises Fellow. It is a privilege for an Austrian scholar to be a Mises Fellow and conduct research at the Mises Institute, and I looked forward to being a Fellow for a long time. So, I really worked hard to be eligible to apply for a fellowship. I attended Austrian reading groups organized by Peter Klein, and I attended Mises University and the Rothbard Graduate Seminar. Also, during that time I heard good things about being a Mises Fellow from my advisor, and my colleagues Per Bylund and Jim Chappelow, who helped me make good preparations.TA: What was the nature of your academic work while at the Mises Institute?JW: Herbert J. Davenport was a main interest, especially the link between him and Frank Knight in entrepreneurship studies. I have had a strong passion for studying the history of economic thought for quite a long time, and I was very excited to work on this during the whole summer as a Mises Fellow. Davenport was a very prominent American economist of the Austrian school during the early twentieth century. Unfortunately, he is nearly forgotten by the mainstream economists, and even most Austrians. My work tries to highlight his contributions to entrepreneurship studies, and to unravel the mystery of Frank Knight’s idiosyncratic way of illustrating the nature of uncertainty and profit. Meanwhile, I also attempt to understand Davenport’s loan-fund doctrine of capital, and how this impacts Knight’s view of capital and the debate between Knight and Hayek on capital theory.TA: What was your favorite part of being a Fellow?JW: It is very difficult to pick my favorite part since there are so many aspects of the experience that I enjoyed a lot. First, it is very convenient to have access to professors’ help and advising every day. Most of the time, I could just knock on their door, and ask questions. Second, I was very fortunate to work in the research wing at the Mises Institute with many brilliant Fellows. Their passions and commitments to Austrian economics encourage me. Third, the Mises Institute is a great place to conduct research, and was an enjoyable and beautiful place to stay. Last but not least, both the professors and staff are very supportive, and they really care about Fellows.TA: How have your experiences with the Mises Institute affected your plans for the future and future academic work?JW: As I have said, I have long had a strong passion for conducting research in the history of economic thought, but early on, I did not have enough courage to do it because it is difficult work, especially for young scholars. I really appreciated the support I received from the Mises Institute that enabled me to learn how to do this type of research, and how to reach out to professors for help. Of course, it is hard to summarize and express the influence of the Mises Summer Fellowship on me, and I may still not know the full impact of it on my career.