01 Apr 2019
But, if recession is coming, do central banks and governments have the monetary and fiscal ammunition to combat it?
“When will the day of reckoning arrive? Unfortunately, none of the empirical studies into the effects of increased debt has discovered the answer. Perhaps it’s like holding your breath, it’s best not to the test the limits."
Central banks control monetary policy - by raising and lowering interest rates they make money dearer or cheaper. But rates are now at rock bottom. Governments can borrow to spend beyond the amount they raise in taxes, but this has now left a worrying overhang of public debt.
What can be done?
Perhaps the answer can be found in John Maynard Keynes’s The General Theory of Employment, Interest and Money, written to explain the Great Depression and where the discipline of macroeconomics was born.
Before the Great Depression economic thought had evolved from the insights of Adam Smith, who revealed how economies operate without any overall coordination, guided as if by an ‘invisible hand’.
Each of us, by trying to better our own situation, improved the situations of all of us, Smith argued.
In essence, the private vice of self-interest was really a public virtue.
To coordinate, or not
Unfortunately, the realisation economic growth was animated by the un-orchestrated actions of individuals was distorted into the notion there should be no coordination at all.
This led to the laisser-faire, free-market theories in which it was argued the economy, left to its own devices, would arrive at the most efficient use of all resources.
During the Great Depression, however, not only were resources not being used efficiently, many were not being used at all. Keynes rebelled against the prevailing opinion of cloistered economists who argued the unemployed workers in queues outside soup kitchens were voluntarily enjoying ‘more leisure time’.
The first part of Keynes’s diagnosis was reduced output led to unemployment. Even Karl Marx, the great critic of capitalism, did not imagine this scenario. His ‘reserve army’ of unemployed workers coexisted with output at full capacity, even if most of that output did go to the capitalists...
Keynes located the problem in the desire of individuals to each increase their saving. For any one person to spend less is insignificant but if everyone reduces their spending at once the consequence is falling profits, lay-offs and production facilities operating below capacity.
Producing and consuming
As Keynes’s colleague Joan Robinson (who should’ve won a Nobel Prize but didn’t due to prejudices still existing today) put it: “what made the General Theory so hard to accept was not its intellectual content, which in a calm mood can easily be mastered, but its shocking implications.”
“Worse than private vices being public benefits, it seemed the new doctrine was the still more disconcerting proposition that private virtues (of thriftiness and careful husbandry) were public vices.”
In effect, Keynes turned Adam Smith’s maxim inside-out: the private virtue of saving was a public vice. And it was this vice which ultimately led to unemployment.
As Keynes mulled this over, he noted two potential remedies: one a cure, the other a palliative.
“Individual saving means that some individuals are producing more than they are consuming,” he wrote. “This surplus may, and should, be used to increase capital equipment. But, unfortunately, this is not the only way in which it can be used. It can also be used to enable other individuals to consume more than they produce.”
Economic pep can be restored—but only temporarily—by encouraging some people to spend more than their income. Whether driven by asset-price wealth effects, increased credit-card debts, or unemployment payments (however necessary), this remedy amounts to borrowing from those who want to save.
Even such “wasteful” ideas as burying banknotes under rubbish in disused coalmines to be recovered by private enterprise would be better than nothing according to Keynes.
But no-one can live beyond their means forever.
Borrowing for spending which doesn’t create new wealth is only a palliative—not a cure for an economic slump. It’s certainly not responsible policy or housekeeping. The day of reckoning has merely been delayed. Current concerns about the high level of global debt relate to the observed side-effects of the palliative remedies applied to date.
When will the day of reckoning arrive? Unfortunately, none of the empirical studies into the effects of increased debt has discovered the answer. Perhaps it’s like holding your breath, it’s best not to the test the limits.
Instead, Keynes recommended sustained investment spending—new infrastructure, new and better houses, improved roads, and other productive assets—to mop up the savings threatening to drown the system. If private enterprise will not fill the gap, then the government can and must.
Monetary policy, by lowering the cost of funds has done its part, but it cannot be relied on alone. The only sure remedy for the public vice of saving is public investment.
James Culham is Director, Institutional Portfolio Management at ANZ
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
01 Apr 2019
08 Feb 2018