Alice in Wonderland Economics Gets Even Crazier

9 mins. to read
Alice in Wonderland Economics Gets Even Crazier

Get ready for a world of negative interest rates and helicopter money. The lunatics have taken over the asylum.

In May I wrote about how the world of the Zero Interest Rate Policy (ZIRP) was one of Alice in Wonderland economics with all kinds of unforeseen consequences over the long term. And last week I discussed how the Bank of England Governor’s attempts to lower interest rates after the Brexit shock sent confusing signals to the markets.

Today I want to dig a little deeper and to speculate on how Alice in Wonderland economics is likely to get even crazier before sanity is finally restored. (If ever). I have just listened to a BBC R4 documentary entitled How Low Can rates Go?[i] by Martin Wolf, the chief economics commentator at the Financial Times. This has given much food for thought.

Now I have to get something off my chest. I regard both the Financial Times and The Economist as mouthpieces for the prevailing economic orthodoxy. You don’t have to be a Marxist like Antonio Gramsci to believe that, throughout history, orthodoxy is the ideology of the prevailing elite. Orthodoxy means keeping things the same – even when the consequences are deleterious. Orthodoxy is always biased in favour of the status quo. Orthodoxy is usually about tautological semantics (things are so because they are so…). I could name several writers on the FT whose main task is to restate received wisdom in ever more clichéd ways. The lame arguments with which they fought the REMAIN cause just confirmed my prejudice.

That said (rant over), what Martin Wolf writes is always worth noting, not least because he seeks to stress test his ideas. He is also remarkably well connected. (Of course – he is a member of the extended governing elite who rules us.) So, to get back to the Radio 4 programme, how low does he think interest rates might go?

Negative – and then more negative. And when that still doesn’t succeed in stimulating demand we shall head into the weird world of helicopter money.

In the April edition of Master Investor Magazine I wrote a review of ex-BoE Governor Mervyn King’s book about the financial system, The End of Alchemy. Lord King is adamant that when interest rates were slashed to near-zero (0.5 percent in the case of the UK) in the aftermath of the 2008 Credit Crunch, none of the experts supposed that they would still be at near-zero more than seven years later. There has been no return to “normality”. Something fundamental has changed in the world economy.

That fundamental something is: the pitifully low growth in demand – not the same thing as economic growth, but closely correlated with it. To clarify: it means that firms are reluctant to invest and households are wary of spending. No one country can escape from this trap on its own. Central banks in the West have thus sought to stimulate demand with ZIRP and by means of quantitative easing (QE) – an artificial increase in the money supply through various types of technical intervention. But it is now pretty clear – even to the central bankers and their clients – that ZIRP plus QE has not fixed the problem. Demand is still sluggish.

While most central banks have set a 2 percent inflation target (the supposed optimum level) the Western world has teetered on the edge of deflation. As I have written before, there are diminishing marginal returns in monetary policy – just as a drug addict needs larger doses to get the same high over time.

So the central bankers and monetary economists have begun to challenge the conventional view that interest rates cannot fall below zero. Of course they can, they now concur. We can set interest rates at negative levels and charge savers for looking after their money. The Swiss have been doing it for years. Currently five central banks – those of the Eurozone (the ECB), Switzerland, Denmark, Sweden and Japan (BoJ), collectively about one fifth of the global economy – have set interest rates below zero. That means that commercial banks pay the central bank to hold overnight money.

The Bank of Japan has pursued ZIRP for nearly 20 years. But even there, the move to negative interest rates in January this year surprised the markets. Japan has endured a prolonged period of modest deflation. In such an environment consumers postpone spending decisions because they figure that goods will be cheaper tomorrow than they are today. In such an environment it has proven very hard to shift consumers’ inflationary expectations. Indeed, the only major economy where inflation is even near that standard 2 percent target is that of the USA.

Two of my own observations here. The first is that a true negative interest rate policy would not only entail charging savers for saving, but also would involve paying borrowers to borrow. And we are still far from that. Second, all the talk about a savings glut implies that companies and individuals are saving too much. While it is true that the corporate sector (especially in America) is sitting on huge cash piles (hence the fashion for share buy-backs) in the personal sector the savings ratio has been falling. In the UK the savings ratio has fallen from 12 percent in 2010 to 4 percent today as people have lost the savings habit. There are numerous reasons for this. Anecdotally, it seems that a lot of millennials have given up the dream of buying their own home and have instead splurged their nest eggs on holidays and trinkets. But the point is that if ZIRP is designed to discourage saving (stimulate dis-saving) it has come too late because there is little saving left.

One reason why monetary policy no longer works in stimulating demand is that post-Crunch we are saddled with huge overhangs of debt. As Adair Turner points out, once you reach a certain level of debt you are dependent on low interest rates to sustain them. (I have pointed out numerous times on these pages that if interest rates were to normalise overnight then virtually all Western governments would go broke.) But low interest rates encourage higher levels of debt: it is a vicious circle – from which, right now, there is no obvious escape. That said, the argument is gaining force that, since rates are so incredibly low, governments should seek to stimulate the economy by good old fiscal means – borrowing money and spending it. (I call the proponents of this policy fiscal revivalists.) We now know that Mrs May and Mr Hammond will not seek to eliminate the deficit by 2020, and that that propitious day continues to recede further into the future. We, like many others, are hooked on debt forever.

Ottmar Issing, the veteran German economist who was on the board of the ECB, thinks that protracted ZIRP has seriously negative consequences for the financial sector. For life insurance companies, he says, this is a deadly threat. The risks to the pensions industry are also considerable. Savings for retirement plans by ordinary folk have been hammered.

The social justice implications of ZIRP are now apparent. A small number of wealthy people have made money as asset prices – stocks, property etc. – have been artificially pumped up, while the vast majority of ordinary people have lost out. Hitherto the state has sought to reward people for provident behaviour; now it seeks to punish them.

So the next step beyond ZIRP would be a Negative Interest Rate Policy (NIRP) where even ordinary savers are charged for saving money. Lord King invokes behavioural economics to question the key assumption behind the negative interest rate model. He says that, even if rates were reduced to minus ten percent per annum, people would still not spend since they would reason that things are so bad that they had to preserve their capital!

But if ZIRP isn’t likely to work either, don’t worry – there’s helicopter money. This is the idea, first postulated by Milton Freedman, that the government could just print money and drop it on the populace from a helicopter. They would then, presumably, spend it. Until recently, economists assumed that Freedman was joking. Now they are seriously considering this option. And it might work something like this. The Treasury would agree that every taxpayer should be awarded a “tax rebate”. The Central Bank then credits every taxpayers’ bank account with an equal “tax rebate” using money that it alone can conjure into existence.

Let’s just note that the Corbyn-MacDonnell thought machine is well ahead of the curve here. They have already posited the notion that a programme of public works could be financed by helicopter money – perhaps the construction workers could be paid by the money conjured up by the central bank. In this regard at least, they should be taken seriously – even though it goes against the grain of our deep-seated Protestant work ethic, where a worker is paid honestly for his toil. Certainly Ottmar Issing is suspicious of helicopter money, describing it as politically dangerous. I think he is right. Once the state starts to function with imaginary money, anything becomes possible: everybody would want to get in on the act. Indeed, why should we have to work at all?

We now live in a system where fiscal policy (tax and expenditure) is determined by elected politicians and monetary policy is determined by the secret conclaves of unelected central bankers. Who would decide on helicopter money? It would challenge our institutional framework. But, at this rate, it is probably going to happen anyway.

Andy Haldane, Chief Economist at the Bank of England (whom I mentioned last time) has put the case for the replacement of physical cash with digital cash (perhaps like Bitcoin), the value of which could be adjusted, up or down, at the click of a central banker’s mouse. We knew that they were out to abolish cash – just look at the withdrawal of the Euro 500 note by the ECB – but they are now getting quite open about it. Why? Because electronic money would make monetary policy (including helicopter money) much easier to implement. Actually, most money in circulation is digital anyway. I am not sure that we the people will buy it – but will we be asked?

ZIRP has kept zombie banks and businesses alive and has restrained productivity growth. The world economy is excessively risk averse, but this, in my view, has been exacerbated by ZIRP which has suppressed the return on capital.

The political fallout of Alice in Wonderland economics has been monumental. Real wages have not risen in the UK for ten years according to the Institute for Fiscal Studies. Populist politics – Trump, Brexit, Italy’s 5 Star Movement etc. – have arisen, for good or ill, in the age of ZIRP. I will explain shortly why I believe that there is an important linkage between ZIRP and mass migration. Further, the inexorable rise in geopolitical risk, which I have been banging on about in these pages for the last year, has taken place hand-in-hand with the failure of the new economics. I shall unpack this soon.

In the final stage of financial capitalism, the Marxists will meet themselves coming back. Of course Labour will split: but the Blairites and social democrats will be massacred as Mr Corbyn drapes himself in the gaudy colours of helicopter money. The Marxists will go into the 2020 election with a policy that makes any promise possible, and they will be backed up intellectually by the global priestly caste of central bankers, The Economist and the Financial Times.

Alice in Wonderland squared.

[i] Details of the programme and iPlayer at:

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