There Ain’t No Such Thing as a Free Lunch – Part 1
In science, the universe is assumed to be a closed object, meaning that it does not receive energy or matter from outside. As a natural self-organized system, the economy seems to share this fundamental characteristic. Greg Mankiw wrote that ‘to get one thing that we like, we usually have to give up another thing that we like.’ In other words, in the economic world, someone must pay the price for any change impacting agents.
The no-free lunch concept is crucial when discussing the potential effects of quantitative easing policies, also known as Modern Monetary Theory (MMT). According to MMT, central banks can set zero or negative rates for as long as needed. They can also purchase infinite amount of public debt, corporate bonds, stocks or even private loans. But such a flexibility comes at a cost.
« You can only get something for nothing if you have previously gotten nothing for something ».
Unconventional dovish measures were introduced to save the economy right after Lehman’s collapse. Inspired by Keynesian lessons from the 1930’s Great Depression, they were first regarded as a necessary exception to stabilize the system. But ten years after Fed launched the TARP, quantitative easing has become a permanent state in the main economic regions of the world. Going further, global leaders are now talking about the possibility of ‘helicopter money’ in the future.
There are many ways to justify the use of money printing today. The most relevant one in my opinion is that quantitative easing has become necessary to handle the debt problem of developed countries and to counter demographic deflationary pressures. But what is its actual impact on the economy?
A few years ago, some economists and strategists stated that mixed with fiscal stimulus, low or negative interest rates would force agents to reallocate money to riskier investment, lying the ground for future economic growth and price inflation. Unfortunately, such a belief has not been supported by facts. Although financial and real-estate assets have effectively soared, the effect of QE on both GDP and CPI has been disappointing compared with the past 40 years. And beyond economic data, the rise of social and political tensions among Western democracies indicates that something might be going wrong.
The reason lies in the negative externalities produced by dovish policies. Indeed, QE has generated a form of moral hazard on investment markets, leading to powerful assets price inflation; a tremendous trend that has been visible on bonds, equities and real estate markets. But you can’t have your cake and eat it too, and asset inflation has translated into wealth inequalities. Said differently, a growing part of the population is now getting more and more squeezed in financial terms because of MMT.
Asset inflation and social stability
To illustrate that, consider a middle-class individual that earned CU 100 per month three years ago, spending 25 for housing and saving 5. Assuming no wages inflation but significant assets inflation, she/he may now spend 35 for housing and may have to save 10 in order to generate the same future revenues as before (because of lower interest rates). What remains at the end is only 55 versus 70 before asset inflation. Therefore, you might expect more consumption arbitrages from her/him, leading to possible deflationary pressures in the economy. And this is exactly what you see when studying recent consumption trends in the US or in Europe.
So, who is paying the price of Western monetary policies? One part of the answer lies into the opposition between ‘the haves’ and ‘the haves not’. The former may be younger people, mostly Millennials, belonging to the middle class or the working class.
To summarize, we can regard QE as a powerful tool to protect wealth and prevent a severe confidence shock in the economy such as the one provoked by the Wall Street Crash of 1929 (as brilliantly documented by John Kenneth Galbraith). And such strategy has been quite effective for now.
But the question is: how long can we keep on squeezing a growing part of the population without risking social unrest and political chaos? Some recent events like the ‘yellow vests’ protest in France should be seen as a warning sign.
This article was originally published on LinkedIn June 15, 2019.