Economic tools aren’t working: any alternatives to Keynesian policies?

  

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Some days, when my mind is wandering in a stagnant pool of nothingness (don’t ask, don’t tell) I decide to punish it even more by thinking about economics as practiced by real-life policy makers.  After reflecting on the reflections from the house of mirrors that is a dynamic mix of neo-Keynesianism and Monetarism, the stagnant pool looks downright enlightening in comparison.   

Lest I bore you too completely, I will try to make this short and sweet in an attempt to explain why the policy mix flowing from the large foreheads of our elite PhD’s in charge of the game is not working.  Let me start out once again with a chart I have shared here many times before, as I think this is central to the story—Monetary Velocity:  

This chart effectively says—you can lead a horse to water but you can’t make him drink.  In other words, when people are afraid, they are not going to demand and hold higher cash balances and use that to help reduce their fears by paying down debt. Therefore, the money pushed into the banking system is less simulative to the real economy. 
Monetarism fails when the experiment starts off with high debt levels and maximum fear among the lab rats—us! The fall in monetary velocity is directly and highly negatively correlated to fear.  

There is a bunch of esoteric stuff in between here, but as I said, lest I put you to sleep, I will cut to the chase:  

• If money is not getting into the real economy as it would if monetary velocity were stable or rising; why is there a belief that taking money from the private sector, in the form of government stimulus programs, will help this situation?   

Well, there is a belief thanks to neo-Keynesianism theory.  People like Larry Summers and Paul Krugman proudly carry the torch of confusion.   

But if the money multiplier from stimulus is less than 1.0, as most new and credible studies have shown regarding the Obama Administration stimulus package, it means valuable resources are being wasted and more importantly the private sector—where real growth will ultimately flow from—is being hampered by that theoretically designed to help.  

And guess who is now getting into this game in a big way?  Yup, the Eurozone!  

Their policy prescription is a bit different.  At least they are attempting to reign in fiscal stimulus, but kill the golden goose of productive capacity by draconian taxes and regulations.  
Thus, the money being forced into the Eurozone is ending up where:  On the banks’ balance sheets just as it has done here in the US; and just as in the US very little of the money will likely make it to the private sector to drive real fresh growth.      

According to the recent Economist magazine: “The flood of money being pumped into the banks by the European Central Bank goes a long way towards easing the funding pressures ... Now that banks are getting funding, the big worry is whether they will do more than merely hoard it.  The early signs are not encouraging.  Over the Christmas weekend bank deposits at the ECB rose to a record €412 billion.”          

To sum up:  

• Zero and negative interest rates are not forcing people to consume because there are so many opportunities to pay down still high debts on their own balance sheets. [Policy failure #1]

• Boosting liquidity to the financial economy is not having a “wealth effect” thanks to the fact consumers’ largest asset—his home—is deeply underwater. [Policy failure #2]

• Driving liquidity into banking reserves is not leading to real economy lending thanks to huge debt overhang and non-functioning interbank market when rates are so low. [Policy failure #3]

• Adding public debt, i.e. fiscal stimulus, is a detriment to the private sectors ability to recover and create real growth and jobs. [Policy failure #4]

How about someone in charge admit the economic tools being used don’t fit the job.  I would suggest giving this a try:  

1. Drastically reduce the size of government. 

2. Then you could drastically reduce the tax burden on entrepreneurs and those that want to grow a business. 

3. Tell the Fed to let the interbank lending market function with normalized short-term interest rates instead of zero interest rate policy that did nothing in Japan but delay its recovery. 

4. Force banking to be dull again ... no more wild bets with taxpayer money—just loan it to real people with character who can use it productively in the real economy and will likely pay it back. 

Maybe this isn’t enough.  Maybe the four points I shared above are the wrong mix.  But if the policy path remains the same, we are likely destined for many years of very slow growth at best, or another major global depression at worst.  So try something else.   Happy New Year!