It was bound to happen – the return of the anti-Keynesians en force. Their case: mass government stimuli are no solution to a) a global crisis and b) a crisis of debt that transcends all previous crises of debt in terms of size. There’s also the fact that Keynes wasn’t always right on everything. Hence his famous quote: “When the facts change, I change my mind…”
Don’t get us wrong, we know there have always been anti-stimulus mumblings. But we feel it is only now that the concept is really picking up any noticeable momentum – the mainstream press having largely lapped up the concept of ‘stimulus’ spending as an economic fait accompli.
But as we are increasingly hearing (and as err, Natwest would say) there is another way – saving not spending.
Making anti-Keynesian case in the FT on Tuesday is Niall Ferguson, senior adviser to GLG Partners and FT contributing editor. As he puts it (our emphasis):
The reality being repressed is that the western world is suffering a crisis of excessive indebtedness. Many governments are too highly leveraged, as are many corporations. More importantly, households are groaning under unprecedented debt burdens. Worst of all are the banks. The best evidence that we are in denial about this is the widespread belief that the crisis can be overcome by creating yet more debt.
The US could end up running a deficit of more than 10 per cent of gross domestic product this year (adding the cost of the stimulus package to the Congressional Budget Office’s optimistic 8.3 per cent forecast). Today’s born-again Keynesians seem to have forgotten that their prescription of a deficit-financed fiscal stimulus stood the best chance of working in a more or less closed economy. But this is a globalised world, where unco-ordinated profligacy by national governments is more likely to generate bond market and currency market volatility than a return to growth.
Ferguson instead proposes the idea of debt reduction. The banks he says are de facto insolvent, and therefore must be restructured rather than nationalised (nationalisation not being a good term when trying re-install confidence). Accordingly shareholders must face up to the fact they have lost money; too bad for them as they really should have kept a more vigilant eye on their board members. Bondholders, meanwhile, should also accept either a debt-for-equity swap or a 20 per cent “haircut”, disappointing but not as bad as Lehman bondholders fared.
Either way, the precedent lies in the Swedish banking crisis, says Ferguson – where banks were indeed temporarily nationalised and accordingly restructured. Although as he also stresses:
The critical point is to avoid the nightmare of a state-dominated financial sector. The last thing America needs is to have all its banks run like the rail company Amtrak or, worse, the Internal Revenue Service. State life-support for moribund dinosaur banks is an expedient designed to avert the disaster of a generalised banking extinction not a belated victory for socialism. It should not and must not impede the formation of new banks by the private sector. So recapitalisation must be a once-only event, with no enduring government guarantees or subsidies. There should be a clear timetable for “reprivatisation” within, say, 10 years.
So, for the scheme to work, reprivatisation must be firmly on the cards (as it was in the Swedish model) and new ‘good’ banks must also be formed in the private sector at the same time.
Also crucial for the plan to work, says Ferguson, is an orderly conversion of adjustable rate mortgages to take account of the fundamentally altered financial environment. Hence, no default, just more lenient terms. While this may seem unfair, the moral hazard element is only really relevant if it encourages people to re-offend. But, as Ferguson points out; “I do not foresee anyone asking for or being given an option adjustable rate mortgage for many, many years.”
Steen Jakobsen, Chief Investment Officer at Denmark’s Saxo Bank echoes the sentiment in his latest blog post too. He does so while taking particular offence at Pimco’s Bill Gross, he of “government should be buying securities to support asset prices” philosophy. For one, he highlights the obvious Grossian conflict of interest (our emphasis):
…it’s kind of interesting to see how a well paid, “well respected” investor like Mr. Pimco seems to think that the solution to all the problems in the world is for the US Government to buy assets he is long – there is no talk of the small matter of funding this small exercise- only the notion that spending money is good.
I find its perplexing that in a time where we need everyone to think positively about solutions that Wall Street and its derivatives continues to look for ways of lining their pockets with state subsidised money. For the record Gross is even intellectually wrong: In order to stop the rot in the financial markets we need to reduce debt to equity not increase Mr. Gross…..
Jakobsen instead is a believer in George Soros, who recently expressed how he believes the current crisis is much greater than in the 1930s because the scale of debt in respect of the US economy to the rest of world is twice as big (hence not a candidate for Keynsian solutions).
With that in mind, Jakobsen refers to the chart below. It depicts Saxo’s leading indicator model vs World GDP growth per capita. As he highlights, the results are not good – they indicate global growth could reverse to as much as a -2.0 per cent contraction in a worryingly short time.
If the above really is a sign of things to come the argument goes the crisis could indeed go beyond the realms of what some would call ‘crass Keynsianism‘can achieve.
As to the solution then, Soros – like Ferguson – believes only the creation of a good bank as opposed to a bad bank can actually help. Soros has one further trick up his sleeve, however. He believes that to truly solve the crisis authorities must create money both domestically and internationally, something which he says can be accomplished via a massive expansion in IMF special drawing rights to the trillions of dollars.
As he told CNBC’s Maria Bartiromo at Davos:
What we are doing, we are creating money to make up for the– for the collapse of– credit. We need to do that internationally. And there is a mechanism. It already exists. It’s called special drawing rights. So we ought to issue special drawing rights on a very large scale, like $1 trillion, and then the rich countries would lend or donate, preferably donate, their allocations to– (the poorer countries).
And that is what the– that would be the, let’s say, the centerpiece of– there are other measures that need to be taken. But that’s the one that would make– it would be similar to the stimulus– that we are passing in the United States.
It’s certainly some food for thought.
Related links:
A paper-gold reserve system? – FT Alphaville
How to solve a balance-sheet recession – FT Alphaville
Niall Ferguson: Beyond the age of leverage – FT