It has been a decade since the Federal Reserve and other central banks began cutting interest rates to zero -- or even below -- and injecting unprecedented amounts of cash into the global financial system via quantitative easing. And while global stocks are at or near record highs, central banks around the world are increasingly abandoning their hopes of normalizing policy with economic growth slowing. On top of that, public and private debt levels are higher than ever.
Some central banks are prepared to take drastic measures. In February, the staff at the International Monetary Fund published a guide to make even more negative interest rates work. Meanwhile, proponents of “modern monetary theory” argue that governments should generate money and distribute it across the economy, until it reaches full employment.
It’s clear that central bank growth models are broken and the fix isn’t more money printing. While saving our economy from a deeper crisis, central bank liquidity injections only delayed this inevitable reckoning. Since the Bretton Woods agreement in 1944, Western governments have used private and public debt to achieve the higher levels of prosperity promised to their electorates. Private debt outgrew gross domestic product by four times in the US since the 1960s. The Institute of International Finance says global debt stands at $243 trillion, more than three times worldwide gross domestic product.
Monetary policy helped cushion downturns and kick the debt can further down the road. Yet this has come at the cost of deeper long-term fragilities. Persistent low interest rates have made the financial system more levered, encouraging risk-taking. They have also increased social and corporate inequality -- making the rich richer and giving large firms an advantage through cheap funding in bond markets.
While many agree that the current mix of fiscal and monetary policy is not sustainable, few have offered realistic alternatives. Here are three:
First, policymakers need to ensure a boom-bust financial crisis doesn’t happen again. This means reducing both the likelihood as well as the potential losses incurred. Asset-driven monetary policy does exactly the opposite: devaluing the purchasing power of money and inflating asset bubbles from government debt to property, art, collectibles, growth and high-dividend stocks. Central banks should make financial stability and macroprudential measures a primary mandate, and assess the long-term risks of each stimulus action, as the Bank for International Settlements has long argued.
In addition, flexible financial instruments can limit the damage in a crisis. Debt-heavy capital structures are cheap to finance in good times, but become quickly unsustainable in a downturn and require a long period to de-lever, forcing policymakers to keep rates low for that time. More equity and flexible debt, such as “bail in” or growth-linked bonds, mean investors can take losses in a downturn and borrowers can move on more quickly. GDP-linked debt has been endorsed by the IMF, the Bank of England and several groups of investors.
Second, we need to strengthen productivity and investment in the real economy. Capitalism isn’t capitalism without competition. Low rates have allowed inefficient firms to survive, and large firms to entrench into monopolies or oligopolies. Investment declined as CEOs focused on optimizing their firms’ capital structures. Corporate pretax profits have grown from 5 percent to 9 percent of US GDP since the late 1990s, while wages shrank from 46 percent to 43 percent, according to Federal Reserve data. Inefficient firms surviving for too long means their workers’ skills remain less flexible and adaptable to new jobs. Governments can promote retraining for the jobs of the future, as Australia has been doing with heavy industry workers.
Third, we have to rebalance the inequalities generated by decades of debt-driven growth. There is no capitalism without meritocracy. Our education system, however, compounds inequality rather than improving it. Graduate admissions for new students remain highly dependent on their family’s wealth, and the postcode where you were born accounts for around 80 percent of your lifetime earnings. Tax systems are progressive from poor to middle-income earners, and regressive thereafter. Taxes paid by multinationals are 9 percent lower than pre-crisis, according to Financial Times estimates, while about 8 percent of the world’s financial wealth sits in tax havens, according to research by University of California-Berkeley economics professor Gabriel Zucman. This is equivalent to $200 billion in tax revenue lost per year.
Debt-driven growth, corporate entrenchment, lack of investment and rising inequalities have turned capitalism into a shortsighted game of kick-the-can. Central banks have bought us time, giving policymakers an opportunity to rebalance the system. If monetary policy remains the only game in town, we all lose.
Alberto Gallo Alberto Gallo is partner at Algebris Investments and portfolio manager for the Algebris Macro Credit Fund. -- Ed.
