The Religion of Economics
The problems posed by negative rates are mostly practical in nature, but they come with some deeply disturbing side effects. In the discussion above I didn’t venture into the theoretical problems of misallocation of capital, the negating of Schumpeter’s creative destruction cycle, the even more intense repression of savers and retirees, and the absolute devastation negative rates would wreak up on pension, endowment, and insurance company portfolios.
In a world of ultralow rates, pension funds that are targeting 71Ž2% growth in order to meet their funding needs 20 years out will find those targets are impossible to attain (as they are today, only moreso). It is not yet obvious to the general public how deeply underfunded pensions are, because pension funds are still assuming that future returns will be in the 71Ž2-8% range. That pension or annuity you are counting on for your retirement is most likely in serious trouble. And as people get older and have no practical way to go back to work, pension funds that are forced to reduce payments in 10 or 15 years (and some even sooner) will destroy the lifestyles of many of our elderly. You think there is a violent backlash among voters today? Just screw around with pensions…
So what would make central bankers around the world agree that negative rates are a solution to our current economic malaise? And that, with all their known negative consequences, not to mention their unknown unintended consequences, negative rates are better than the alternative?
I have been trying to devise an explanation of the negative rates proposition that most people can grasp by likening prevailing economic theories to a religion. Everyone understands that there is an element of faith in their own religious views, and I am going to suggest that a similar act of faith is required if one is believe in academic economics. Economics and religion are actually quite similar. They are belief systems that try to optimize outcomes. For the religious that outcome is getting to heaven, and for economists it is achieving robust economic growth – heaven on earth.
I fully recognize that I’m treading on delicate ground here, with the potential to offend pretty much everyone. My intention is to not to belittle either religion or economics, but to help you understand why central bankers take the actions they do.
This explanation will need a little set-up. I have noted before, in an effort to be humorous, that when you become a central banker you are taken into a back room and given gene therapy that makes you always and everywhere opposed to deflation. Actually, this visceral aversion is imparted during academic training in the generally elite schools from which central bankers are chosen.
This is our heritage; it’s learning derived not only from the Great Depression but from all of the other deflationary crashes in our history, too, not just in the US but globally. When you are sitting on the board of a central bank, your one overriding rule is never to allow deflation to occur on your watch. No one wants to be thought responsible for bringing about another Great Depression.
And let’s be clear, without the radical actions taken in 2008–09 to bail out the banks, drop rates to the zero bound, and institute quantitative easing, we would likely have been facing something similar to the Great Depression. While I don’t like the manner in which we chose to bail out the banks, some form of bailout was a necessary evil.
Think deflationary depressions can’t happen today? Clearly, they can. Greece, for all intents and purposes, has sunk into a massive deflationary depression. That reality is not necessarily reflected in the prices of their goods, which are denominated in euros. No, the deflationary depression in Greece is in their labor market.