With the world gripped in a deep deflationary trap and seemingly no clear way out, former UK Financial Services Authority chief Lord Turner is advocating a policy of debt monetisation, with central banks financing major fiscal deficits.
Lord Adair Turner actually took up his post at the Financial Services Authority, just five days after the collapse of Lehman Brothers, so was immediately thrust into the process of attempting to shore up the UK banking system.
As chair of the major policy committee of the Financial Stability Board he was closely involved in re-regulating the global economy and believes the banking system is now much safer and won’t face another crisis along the lines of 2008.
What he is concerned about, however, as he explained in an interview with Real Vision TV this week, is the level of public and private debt in the global economy, which is higher than ever and continually growing. Speaking to Real Vision, Lord Turner said with interest rates close to zero, or negative in some countries, it just creates more incentive for people to create more debt.
Stuck in a Hole and Still Digging Deeper
“So you’re caught in a trap where the only solution to the trap is to make the trap a bit deeper. It really is. When you’re in a hole you’re still digging,” Turner said. “So that is I think the fundamental problem facing the global economy and why, having just come back from the IMF meetings in DC, why the IMF has, for about the fifth year in a row, reduced its forecasts of global economic growth. We are in a deeply profound deflationary trap and we don’t have perfect answers to get out of it.”
One thing that is clear, Turner said, is the tools being used to try and get economies going again and inflation back to target are not working, leading to calls for monetary policy to be replaced with a fiscal response. “When you first do a QE operation and drive down the long end of the yield curve by buying bonds, it has a first order effect. But after a time, more of the same really doesn’t stimulate the economy and it’s pretty simple why it doesn’t.
“Once businesses or consumers are already paying very, very low interest rates, marginal further reductions in the interest rates doesn’t make them rush out and invest or spend more. So we’ve got a set of tools that are not working. The alternative tool, and this is being increasingly discussed across the world, is fiscal stimulus. Lower taxes, higher expenditure, many people would say on infrastructure, etc.”
Print the Money to Finance Fiscal Deficits
Turner said that the typical response to higher fiscal deficits is that we already have existing debt, so there is nothing that can be done and we’re out of ammunition. “The point I’ve made is if our problem is that we don’t have enough demand in the economy, if our problem is that we don’t have enough inflation, rather than too much inflation, then we never run out of ammunition. Because there’s always something that we can do, which is to run fiscal deficits and finance them with central bank printed money.”
While this policy is considered dangerous, even madness, if there is too much inflation, with structural and supply side problems meaning there is no benefit to stimulating the economy, Turner contends that you still have to know that tool is available. He’s not recommending it everywhere, but Japan is a prime candidate.
“I don’t think that there is any possibility whatsoever that Japanese government debt is going to return to quote “sustainable levels” through the normal mechanism of turning a fiscal deficit into a fiscal surplus and paying down the debt. It simply isn’t going to occur. And I don’t think there are any situations whatsoever in which the JGBs, which have been bought by the Bank of Japan, are ever going to be sold back to the private sector,” Turner said.
“So in effect, in Japan there has been a permanent monetisation. But it would be better to admit to it and to put that monetisation within the discipline of a clear theory about why we are doing it and a set of institutional rules about how much you do, rather than to continue see as Japan is in a fantasy land where it says that this is a temporary exercise even though it clearly is not.”
Sooner or Later the Market will Wake Up — Breaking the Taboo
Fast forward to some time in 2021 or 2022 and Turner said there won’t be a single Japanese government bond that isn’t owned by either the Bank of Japan or the Japanese social security fund, so sooner or later the market is going to wake up to the fact that this liability doesn’t really exist if it’s all owed to various wings of the Japanese government.
“Part of the problem is that they keep on telling the Japanese people that it does exist. The Japanese people face 250% debt to GDP. That they better get used to the idea that there will be higher taxes in future. In which case, not surprisingly, the Japanese people and companies say, well I’d better save some money. So it keeps the economy depressed,” he said.
The solution would be to give authority to the Bank of Japan’s Monetary Policy Committee to say that some of this debt should be written off and replaced on the Bank of Japan’s balance sheet by an entirely notional, perpetual non-interest bearing bond.
“For the Bank of Japan that’s completely sustainable because on the liability side of the Bank of Japan there are monetary reserves. And although people often don’t think about this, what money is, ultimately, is a perpetual, non-interest-bearing bond. That’s what money is. It’s due from the government, which they never have to repay.
“I think we’re stuck in a very difficult position,” he adds. “The central banks treat monetisation as the great taboo. And at one level it’s understandable why they do that. I think until very recently, the central bankers have wanted to believe that they don’t need to go down that route because these other tools, like very low and negative interest rates and quantitative easing, are going to work. But what has really happened over the last six months all the way around the world, is an increasing worry that those tools and, in particular, negative interest rates don’t work. “
Eurozone Debt is Unsustainable — Credibility Crisis for the ECB
Looking at the global debate, the switch to talk of a fiscal expansion is a major change from discussions three years ago and the only division now is the people who want a fiscal stimulus and are not concerned with debt to GDP going up and Turner, who is saying that if you are worried about debt to GDP going up, realise you can write it off.
“And I would argue that the reason why the debt to GDP can just go up and up and up actually is because everybody knows that at the limit, in future, you could write it off. That’s why Japan can issue limitless debt with a gross debt to GDP of 250%. It’s because everybody knows that at the limit it’s not going to default. Rather than default, it will always monetise.”
Turner also said when you hear the phrase that people who have fiscal space must use it they are really referring to Germany. “Part of the trouble,” he said “is the Germans have absolutely no intention whatsoever of loosening their fiscal stance.”
Overall, Turner said he far more concerned about Europe and in particular the Eurozone, which is suffering from a major economic problem with a lack of demand in some areas. “I think it has unresolved and potentially unresolvable debt burdens. We know that Greece is going to have to write off more of the debt, but the one I would watch over time is Italy. I’m not sure that Italian debt is sustainable other than by a mechanism by which ECB buys the Italian government debt.
“I think the eurozone does require a new visionary policy with some element of fiscal stimulus. But I don’t think it’s going to get it because the structure of multiple governments and one central bank, the lack of a central fiscal authority, the lack of trust between the Germans and the Italians and the Greeks with the Germans sitting there saying, yeah but if we agree any fiscal relaxation, that will just be completely undisciplined.
“My concern is that the ECB has enough firepower and credibility that the moment the eurozone looks as if it actually might break up, they can stop it breaking up by a set of interventions, but they don’t have enough firepower to make the eurozone a sufficiently successful economy to offset these really quite frightening stresses, which will then play out in populist politics. Whether it be of the National Front in France or of, essentially, a comedian’s party in Italy. The Five Star Movement of Mr. Grillo.”
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