Even the OECD warns that recent central bank & govt policy is likely to create social unrest…

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4 mins. to read

Keynesian ideals, which aim at smoothing the business cycle and redistributing wealth in a more equitable way than the market does, are dead. And so they should be – last shot at the with the Labour Government, well look how that ended..!

Nowadays, governments around the world hide behind a Keynesian mask, but pursue their own self-interest and the interests of those that are nearest to them. Plain fact is that in recent years Governments have spent too much for too long, evidenced by the massive sovereign debt figures and the continued money printing to service themselves (!). They are now engaged in the hunt for revenues, seeking out the shortest shortcuts possible to squeeze the taxpayer, even when it means acting against the business cycle and in complete dissonance with Keynesian economics. Such behaviour allied with the current monetary policy has been contributing to the enlargement of social inequalities and to the annihilation of the middle class.  

Showing obvious concern, the OECD has just warned the world that if governments are unable to stop the redistribution of wealth to a small financial elite, the displeasure of the dispossessed middle class could easily turn against the prevailing governmental systems. Strong words indeed.

In our view, there are two main sources that have and continue to promote profound social changes; both of which need to be carefully addressed: (1) Excessive government spending for years led to an epic accumulation of debt that has now reached a critical point; (2) Monetary policy is out of control and entering new areas and is becoming ineffective (or at least socially undesirable).

Let’s take a look at both…

Government spending has hit uncontrollable levels with the government-to-GDP ratio for many countries in the developed world now at levels higher than 100%. Keynesian economics advocates government intervention to smooth the business cycle but it does not suggest that governments should spend more than they collect at every point in the cycle.

The idea is to get some fresh momentum so that they end up with a positive balance that would give them a cushion for intervention during downturns. But in most cases, government deficits have existed every year regardless of the business cycle and has resulted in a huge debt pile being accumulated over the years. The 2007-2009 crisis (if we can put an end date to that), has just created a huge gap between collected taxes and necessary expenditures, forcing governments where money printing was not an option to suddenly attempt to try and reverse this debt profile.

Countries like Portugal, Italy, Ireland, Greece, Spain, just to name the worst, were forced to adopt austerity measures during one of the toughest downturns ever, under pressure from an international body of creditors that wanted results in a short period of time. These governments had no other option but to target the part of the population that could bring them more revenues in a short space of time the middle class. This group is by far the easiest to hit as they mostly earn their living from labour related jobs and are usually in a position that doesn’t give them many options to avoid higher taxes.  Therefore, governments hit the population in a very unbalanced way which contributed to an increase in inequality.

While fiscal tightening persists, central banks have been engaged in expansionary policies in an attempt to generate economic growth that can counter-balance the fiscal policy. But the final result has been disastrous. The only tool central banks have at hand is the control lever for the price of money. They lowered interest rates to near zero and expanded the money supply, believing the lower borrowing costs would lead to an increase in consumption and investment. The lower interest rates led to a 250% rise in equity values that however primarily benefited just 10% of the population. While this has had severe consequences in terms of wealth redistribution, it has also been the case that this wealth has not been invested to create spare capacity and to hire. Net new productive investment in many of the worst hit countries is running at v low levels and many companies seem to prefer to just repurchase shares rather than invest in new projects.

Fiscal and monetary policies have contributed to a deterioration in social equality and are in fact preventing economic growth and prosperity from materialising. On average, the top 10% of the population earn 9.5x as much as the lowest 10%, a number that has been increasing over the years. The so called GINI coefficient also shows an increase (lower values mean more equality) as the chart below displays.

We are at a point where we need to rethink economic policy and its future role in society. Governments have, quite simply, just added to the volatility of the business cycle over the years by investing when the cycle was in upturn and cutting expenses when the cycle was in downturn instead of the reverse! At the same time, those that prefer a free market should also not rely on central banks to save them in a crash: if there is no intervention to pop bubbles, there should also not be any in the event of a crash. Similarly, interest rates should be managed with parsimony, as the economy needs time to adjust to new conditions rather than simply adjusting to artificially created situations.

One final comment is reserved for the independence of central banks. Central banks gained independence from governments to avoid political pressure and to maintain money stability, but they are now growing muscles while being out of reach from public scrutiny. If the power of central banks continues to grow, then we may, irony of ironies, need their members to be elected, just the same as any government minister.

Filipe R Costa

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