Via Larry Lindsey of The Lindsey Group…
Negative Rates and the Austrians' End Game
Our training and bias have always been toward policy activism — that tweaking this or changing the dial on that can always make things better. [But] critics of activism, often lumped into the 'Austrian School,' argue that this will inevitably end badly.
Tweaking and dialing are addictive, both to the policymaker and to the governing class. Inevitably, this will lead to an unsustainable amount of tweaking and dialing and an endgame in which policymakers become powerless as the state's monetary and fiscal dials are no longer functional and the state is, in effect, bankrupt. But as states never go bankrupt, they then must seize the assets under their dominion through either inflation, taxation and confiscation.
Our activist training tends to lead us away from these thoughts until [a] more-worldly individual — in this case, an Italian friend and client (and a history buff) — reminded us of this theme.
The Roman Empire tried all three. The medieval popes had their Jubilee Years in which all debts, particularly their own and those of other sovereigns, were forgiven. Debasement, grinding taxation, and confiscation from disfavored groups (often the Jews) were all part of the process.
So, there is nothing new under the sun that shines in the Policy Activists' Universe. Negative interest rates sound new and 'unconventional,' but they are nothing more than an extension of this nostrum. Undertaken in the name of promoting inflation, they are really nothing more than taxation of (and ultimately confiscation of) liquid wealth. They are 'unconventional' only in the context that as time goes on, the policies of state acquisition of wealth must become ever more creative.
A 40- or 50-basis point 'tax' on wealth doesn't sound like much, but in a world in which the 'normal' real return on capital might be 2%, this is a tax on income equivalent to 20 to 25%. Add to this a modest 'inflation tax' of 1% (below the target of 2%), and the new, effective rate on the normal return on capital becomes 70 to 75%.
Done in 'moderation,' inflation, taxation and confiscation can go on for a long time. They persist until the institutions that are the long-term-savings vehicles of a society and provide the investment capital collapse under the burden. How can one offer a pension — except through a Ponzi scheme — when the accumulation of assets is subject to such taxation? Long-term life insurance (as opposed to renewable term insurance) becomes impossible as well.
In the process, the growth of societies trying these schemes diminishes. Long-term capital moves from growth-enhancing productive investment, which dries up as it increasingly gets channeled into the hands of the state. The fibers of the economic morality that drive growth get frayed, particularly the bourgeois impulse to save for a better tomorrow for oneself and one's children.
None of this matters to the guardians of public policy who have finite terms of office, and who tend to see their wisdom as a safer repository for society's wealth than the people who earned and accumulated the wealth.
Our Italian friend is actually optimistic near term. He believes that this can go on in Europe for another five to ten years. The more historically knowledgeable of the bourgeoisie are doing what they have always done: placing increasing amounts of wealth in assets outside of the state's easy reach — art, real estate, gold. Cash and near-cash (government bonds) should be avoided. [But] growth decays, and resources devoted to security are eroded as the funds aren't there. And in his view, the real threat to Europe then becomes external.
We demur that surely in this more-modern democratic age, the knowledgeable bourgeoisie won't let the state do this. Cast your protest votes! But the electorate is getting 84-month low-rate car loans and government-benefit checks, while the haute bourgeoisie are seeing the price of the assets they own inflated. In his view, no one will really move to bring this down until it collapses of its own weight. Then, he says, we will start all over again.
Now, there's a cheery thought!
h/t Seabreeze Partners' Doug Kass
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