'Pessimists' (i.e., Critics) 'Should be Ignored'
David Miles, an external member of the BoE's MPC has published an editorial in the FT (where else?) defending the John Law school of central banking which he evidently belongs to. He manages to contradict himself two paragraphs into his screed, and thereafter goes on a tirade about central bank policies supporting 'demand', as though we could consume ourselves to prosperity. Been there, done that, is actually all one can say to that. It's as if the central bank policy induced bubble that collapsed in 2008 had never happened. In other words, Miles apparently believes his audience has the attention span of a mayfly (about this point, he may actually be right for all we know). The funny thing is that he contradicts himself even while asserting that it is the critics of money printing who contradict themselves.
“Much of the most vocal and opinionated analysis of the impacts of central bank asset purchases – quantitative easing – strikes me as somewhat contradictory. But it is also important and may explain the recent reaction, quite probably an overreaction, to limited news from the Federal Reserve on asset purchases.
Some people seem to believe that large-scale asset purchases by central banks have created bubbles in many markets and that stopping such purchases (let alone reversing them) must cause big falls in prices. Others take the view that these central bank purchases are ineffective in stimulating demand in the wider economy. I think the evidence for either of these positions is weak. But some people believe both things – a position that I think is also contradictory as well as being profoundly pessimistic.
The first claim – that QE has artificially boosted prices to bubble levels – does not stand up. It is certainly true that in purchasing financial assets, central banks – certainly the Bank of England’s Monetary Policy Committee – has deliberately and consciously raised the demand for these assets and that will have supported their price.
Supporting asset prices helps to support growth. It means that many companies find it easier to raise funds, and that many household borrowers face lower longer-term interest rates. And by keeping the value of portfolios of wealth higher than it would have been, the spending of many of the people who own that wealth is supported. Does anyone doubt that many of the households that have seen the value of their savings accounts and other stocks and bonds rise over the past year or so would have been less inclined to spend had these instead fallen sharply in value?”
(emphasis added)
So central banks have not blown another bubble, they have only 'deliberately and consciously supported asset prices'. In other words, they have blown another bubble. No contradiction there at all. The very same argument could have been made after central banks 'deliberately and consciously' created the housing bubble in 2002-2007. It sure 'raised the prices of financial assets', and 'supported demand'. It also led almost to a catastrophic systemic collapse, a severe recession and eventually a sovereign debt crisis, among other things. Why is this time going to be different?
Before we get to that, a brief remark on the fact that Miles continues to stress 'demand', i.e., increased spending in his article. The term 'demand' is mentioned six times. The term 'production' isn't even mentioned once. This is in fact the cardinal error underlying Anglo-Saxon central banking socialism. In order to exercise demand, one must first produce something. Demand that is set into motion by printing money that is enabling exchanges of nothing for something – i.e., consumption without preceding production – only weakens the economy structurally. It falsifies economic calculation and thereby creates phantom profits and phantom wealth, even while real capital is consumed. Evidently, central bankers still haven't realized that. In Miles' imaginary simplistic world, capital is a homogenous blob that springs into action as soon as there is 'demand'. In the real world, things are a tad more complicated.
No Bubbles in Sight Anywhere …
So why is it not a bubble this time? Wasn't the mantra hitherto that central bankers should ignore bubbles because they are supposedly unable to recognize them? We seem to recall that this was an argument forwarded by Alan Greenspan that has been employed as an excuse ever since. Central banks are only supposed to deal with the 'fallout' once a bubble bursts, since they allegedly cannot tell the difference between a fundamentally justified increase in asset prices and a bubble. Apparently Mr. Miles can tell. Not only that, he is convinced that letting the market deal with correcting the errors induced by the previous central bank induced bubble is definitely not the way to go. See, without intervention, there would be a 'self-reinforcing spiral' that would never, ever end. Without central planners distorting interest rates and prices, we would obviously forever be stuck in economic depression.
“One of the ways that financial crises can have drawn-out consequences is when debtors’ balance sheets deteriorate as the assets that they hold lose value. This runs the risk of a negative self-reinforcing spiral – a worsening economic situation pushing down on asset prices further depressing demand. By supporting asset prices, QE has helped to ensure that this sort of negative spiral has not happened in the UK.
If QE had created a bubble, there would be a big risk that values will soon crash. And asset prices have fallen sharply over recent weeks as people reassess the scale of purchases by the Fed. Yet the evidence for a general bubble in asset prices is not very convincing. It is true that until the very recent sell-off the FTSE All-Share index was about back where it was in the summer of 2007 – having fallen by about 40 per cent between mid 2007 and early 2009. But in real (inflation-adjusted) terms, stocks were still down by about 20 per cent from the level they reached in 2007. Price to earnings ratios on those stocks do not look unusually high. Average house prices in the UK are – according to some national measures – only 5-10 per cent lower than the levels at the peak of early 2008. But, in real terms, they are down by about 25 to 30 per cent. Yields on government debt – both in nominal and real terms – are unusually low.
Part of that reflects a belief that central banks are likely to keep short-term interest rates at low levels for some time yet. Part of it is likely to reflect a substantially higher perceived level of risk now relative to before the financial train wreck of 2007-8. That puts a premium on relatively safe assets – such as gilts. So there are good reasons why yields on less risky government debt should be low.”
(emphasis added)
His argument seems to boil down to: “relative to the speed with which we have impoverished people by devaluing the money we issue and which they are forced to use, asset prices are not in bubble territory just yet.”
Well, thanks for nothing. Here is what those who don't own any of the assets the prices of which the central bank has driven higher are facing:
Change in UK real incomes, 2002-2012.
UK price increases of essentials compared to the nominal rise in wages
In other words, by devaluing its money, the central bank has redistributed wealth from the poor to the rich. We're supposed to be grateful for that why exactly? Oh yes, because otherwise we would be in a 'permanent depression', in a 'never-ending downward spiral' and there would be 'no demand' (needless to say, that idea mainly springs from the overactive imaginations of central bankers and their advisors).
Regarding stock market valuation, let us look at the US stock market and see if we can discern any difference between current trailing price-earnings ratios and those at the 2007 peak, since Miles so confidently assures us that 'stocks are not expensive'.
The S&P's trailing P/E ratio today versus that of 2007: difference = zero – click to enlarge.
It actually looks like stocks are just as expensive today as they were then. As an aside, stocks were only marginally more expensive at several of the biggest market peaks in history, such as in 1929, 1973 and 1987. They were cheaper than today at the peak of 1937 (which was followed by a near 60% crash) and the only time in history when stocks went to significantly higher valuations was during the late 1990's bubble. As the chart above shows, the SPX would have to fall by 46% to reach a p/e ratio of 10. At historical secular bear market lows, the index has fallen to mid to high single digit p/e ratios (e.g. in 1932, 1942, 1949, 1974, 1980 and 1982). It is important to keep in mind that this happened both during times of low and times of high interest rates – in other words, low interest rates are not a guarantee it won't happen again.
In closing, Miles remarks that:
“Furthermore, to think that asset purchases do nothing to support demand in the economy you would also have to believe that investment was not at all responsive to a greater availability of funding at lower interest rates. Is that plausible?
A rather less sensational view on the effects of QE is far more plausible. Central bank asset-buying has supported a wide range of prices and this has caused spending to be higher than it would otherwise have been.”
(emphasis added)
The man seems to be harboring the delusion that critics of central bank money printing are arguing that such printing does 'not boost demand' or doesn't 'cause higher spending'. That isn't the argument at all. The argument is: it is an error to believe that sustainable economic growth is the result of 'more spending'. Central bankers are putting the cart before the horse. In reality, it is production that enables consumption, not the other way around.
There is also no question that keeping interest rates artificially low spurs investment – the problem is that a large portion of this investment will at a later stage be unmasked as malinvestment of capital that will likely require an even bigger bust to be liquidated. The balance between investment and consumption is destabilized by throwing more fiduciary media on the market and artificially lowering the interest rate. Nothing good can come of it, even if aggregate economic data can for a while create the false impression that things are going well (just as happened from 2002 to 2007, a time when central bankers were almost gasping for air from all the self-congratulatory back-slapping they engaged in). Central banks don't create wealth, they destroy it.
Conclusion:
We will keep calling the apologists of central banking out (admittedly it's not difficult to demolish their arguments). The central planners at the heart of our economies have obviously learned nothing. By sticking to economic theories that should have long been discredited, they will only create an even bigger catastrophe down the road. Moreover, their policies continue to impoverish the very people – from the poor to the middle class – they purport to be 'helping'. We can only repeat: central banks are a threat to civilization. When will people finally wake up to the fact that central planning just doesn't work?
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