The value of money
Finance doesn’t get the disrespect it deserves. Nothing about money and credit is sacred – certainly not quantity of currency outstanding. The political and monetary authorities should feel free to add and subtract money as needed to help the economy function better.
Consider the current oversupply of debt. Loans can be a very helpful financial tool. But right now, the tool is malfunctioning. The vast quantities of debt sloshing around the global financial system have brought much of the developed world into a sort of financial gridlock. Companies and households restrain their hiring and spending because they feel financially insecure. Governments are reluctant to borrow more because their balance sheets are stretched.
The result: people are unnecessarily and undesirably unemployed, useful investments are not made, and consumption is pointlessly restrained. The efforts to push up economic activity generally involve adding more debt. The financial overhang is not the only weakness in developed economies, but it has amplified the damage done by problems such as income inequality and labour market rigidities.
It’s time for a new approach. If finance were treated as no more than an economic tool, the answer to too much debt would be obvious: stuff balance sheets with enough cash to make them healthy. Here is a very simple, three-step path to significant systemic deleveraging.
First, create a vast sum of money. That is easy. Money, unlike any other important raw material in modern economies, is readily available in infinite quantities. No mines need to be dug, no factories constructed, no skills learned. Central banks can create the stuff, in the form of bank reserves or deposits, with a few regulations and some computers. They already have the computers.
The second step is to distribute the newly created cash. Economists joke about dropping notes from a helicopter, but there is no need to waste fuel. There are more efficient ways to get money into the economy. The government can just spend it. The central bank can give the money to banks or put it directly into the bank accounts of individuals and companies.
The final part of the plan is to ensure that the new money is actually used to deleverage. That could be a little complicated. The government can do it easily enough, by buying back its own debts. But in the private sector, a bit of persuasion might be required to ensure that debt reduction is the first use of cash. The tax code and bank regulations are powerful prods.
This is deleveraging through what British economist Adair Turner calls outright monetary financing (OMF). It is not problem-free. Floods of money can lead to undesirably high inflation rates, because employers and customers can always afford to pay more. Also, there would inevitably be debates about justice – how to be fair in the allocation of free funds.
However, the current monetary timidity has even more problems. With disinflation in the air, leverage becomes ever more toxic for the economy. The financial system is not funding enough healthy development or high-quality jobs. There is also ample injustice. Ultra-low policy interest rates may keep the excessive debts from doing more damage, but they unfairly favour some financial intermediaries and punish all savers.
A few economists, including Willem Buiter of Citigroup and Biagio Bossone of the Group of Lecce in Italy, have spoken out in favour of OMF, at least in exceptional circumstances. But the usual reaction to making large-scale manipulations of the financial system standard practice is horror. Most central bankers even refuse to admit that their quantitative easing is basically a tentative variety of OMF.
The normal view is that money is too special to be messed around with in this cavalier way. Caution is the watchword. Governments are expected to keep deficits small and to fund them only through borrowing, to ensure market discipline. Central banks are ideally impartial and august. Banks are careful. Ordinary citizens are to be shielded from the dangerous knowledge that the supply of money is infinitely flexible.
The common justification for the almost religious approach to finance is that big changes can cripple the economy. That is true in the extreme – hyperinflation and massive currency contractions are indeed devastating. But governments are usually competent enough to avoid such disasters. In a big monetary reworking, the authorities would have to be unusually imaginative, because they could not predict all the responses to an unprecedented policy. The task would be much easier if all the major economies agreed to proceed together.
A major OMF deleveraging might create some hard moments, but there is actually little to worry about. Businessmen and consumers absorb all sorts of changes in laws, technology and business practices. In finance, they adjust quickly to changes in inflation rates. They could certainly deal with the relatively mild shifts that would follow massive money creation.
They should get the chance to try. An excessive fear of economic disruption, combined with a continued willingness to create new debts, is doing great harm. The financial system is an economic tool which sometimes needs to be repaired or modified. Now is a good time for a significant rebuild.
This column has been updated to correct “University of Lecce” to “Group of Lecce” in paragraph 10.