“Mr. Turner holds the conventional view, expressed often and forcefully by former Fed chief Ben Bernanke, that deflation—a fall in the general price level—is to be avoided at all costs. Yet recent research from the Bank for International Settlements finds no statistical link…
…between historical episodes of deflation and weak economic growth. Rather, the researchers conclude, it is excessive credit growth and real-estate bubbles—which are the almost inevitable consequence of over-easy monetary policies—that pose a significant danger to our economic health.”, Edward Chancellor, “The Fed’s Faustian Bargain”, The Wall Street Journal, December 7, 2015
The Fed’s Faustian Bargain
Excessive credit growth and bubbles—the consequence of over-easy monetary policies—are more dangerous than the threat of deflation.
The financial crisis in 2008 caught most policy makers and economists by surprise. Before the eruption of subprime problems, they were remarkably complacent, variously maintaining that the cycle of booms and busts had come to an end; that innovation was making the financial system more robust; and that strong credit growth was nothing to worry about. The theories of orthodox economics held that, because speculative bubbles were difficult to identify, they were best left to grow unchecked. Monetary policy could always be directed at dealing with the bubble’s aftermath.
Adair Turner, a former U.K. financial regulator and member of Britain’s House of Lords, admits that he used to hold such views. His new book, “Between Debt and the Devil,” shows how much conventional wisdom about finance has changed since the crisis. Yet his account provides only a partial explanation of what went wrong in the run-up to the credit crunch, and his proposed fixes—more money printing and the state direction of credit—are alarming. It would seem that once-sober policy makers, having failed dismally to anticipate financial armageddon, are morphing into monetary cranks.
The early chapters of this extensively researched and well-written book explain how, prior to Lehman’s demise, credit-risk models were flawed, financial regulation was inadequate and much new lending was unproductive. The removal of rules restricting capital flows had led to trillions of dollars sloshing around the world in search of higher returns. Too much credit had caused a debt overhang—Mr. Turner believes that this excess debt continues to blight our economic prospects. Such views are not original; nor, in the post-Lehman world, are they controversial.
Mr. Turner blames excessive debt issuance, then and now, on the increasing portion of bank assets tied up in real estate. He blames as well rising inequality and gaping current-account imbalances, both of which, he believes, have led people into borrowing too much. Yet property bubbles, inequality and huge capital flows are best viewed as manifestations of the credit boom that took off after the Fed, led by Alan Greenspan, slashed interest rates in the wake of the dot-com bust in 2000.
BETWEEN DEBT AND THE DEVIL
By Adair Turner
Princeton, 302 pages, $29.95
This is not to say that Mr. Turner doesn’t recognize that the policy of the Federal Reserve has had some ill effects. He acknowledges that low interest rates have encouraged speculation, while quantitative easing—the Fed’s policy of printing money to buy financial securities—has exacerbated inequality by boosting asset prices. “As a cure for the debt hangover,” Mr. Turner dryly notes, “ultra-easy monetary policy is essentially a stiff drink.” Still, he concludes, this policy was “better than nothing,” since the alternative would have been a deeper recession and full-blown deflation.
Mr. Turner holds the conventional view, expressed often and forcefully by former Fed chief Ben Bernanke, that deflation—a fall in the general price level—is to be avoided at all costs. Yet recent research from the Bank for International Settlements finds no statistical link between historical episodes of deflation and weak economic growth. Rather, the researchers conclude, it is excessive credit growth and real-estate bubbles—which are the almost inevitable consequence of over-easy monetary policies—that pose a significant danger to our economic health.
An unwarranted fear of deflation leads Mr. Turner to rule out interest-rate hikes to prevent excessive credit growth, since he fears that the higher cost of money would tip the economy into deflation. In any case, he says, credit is too important a matter to be left to the bankers. The state should have a role in determining how it is allocated, and central bankers should push their current unorthodox policies even further. For instance, they could print money to fund government deficits. The debt overhang could be addressed, in his view, by central banks canceling the government bonds they have acquired with freshly minted money.
Mr. Turner acknowledges that such unconventional measures, once embarked upon, would be difficult to stop. Not long ago, the head of Germany’s Bundesbank delivered a warning by citing a scene from Goethe’s “ Faust”: An emperor is tempted by the devil to print paper to pay off his debts—a story inspired in real life by John Law’s introduction of paper money into France in the early 18th century. After initial success, the emperor’s money printing creates an inflation that eventually destroys the monetary system. Mr. Turner believes that his own proposals for money printing could be better controlled. Goethe and millennia of monetary history suggest otherwise.
Among the many economists cited in “Between Debt and the Devil” is Friedrich Hayek, who, according to Mr. Turner, believed that “private credit creation is inherently unstable.” This misrepresents the Austrian-born economist’s position. Hayek held that credit inflations occur when the central bank sets interest rates too low—the great error of the Federal Reserve both before and after the financial crisis.
Hayek would have been surprised by Mr. Turner’s suggestion that money printing can provide a permanent economic stimulus, since he believed that inflation was only a “temporary fillip.” Inflation acts like a drug, Hayek observed. The first pleasant stimulus soon wears off. Over time, larger and larger doses are needed to work the same effect. Under inflationary conditions, the economy becomes progressively sicker, and wealth is randomly distributed between inflation’s winners and losers. We learned these painful lessons in the 1970s.
The fact that thoughtful policy makers like Mr. Turner are proposing old inflationary cures under the guise of new economic thinking augurs ill for the future direction of economic policy. The failure of one unorthodox monetary measure begets yet another.
Mr. Chancellor is the author of “Devil Take the Hindmost: A History of Financial Speculation.”