It’s hard to imagine now, but at one time monetary policy was only background noise to the economy. For the better part of the twentieth century, most people couldn’t tell you who the current Federal Reserve chairman was. Now Greenspan, Bernanke, and Yellen are common household names. And with all the Fed’s “fixing” of the money supply during the last three decades, it’s no wonder the enormity of today’s financial mess. Excessive debt, interest rates, trade imbalances, capital flows, and energy production – all are out of sync. Human regulation and unintended consequences have circumvented the economic dictums of supply and demand. Economic equilibrium has been sacrificed for the sake of policy goals.
American foreign policy, fiscal policy, and monetary policy all contributed to the world’s production overcapacity following the collapse of the Soviet Union. “Pax Americana,” was the thinking – a period of stability that would carry the world far into the twenty-first century. Worldwide peace and prosperity would ensue under the auspices of U.S. economic and military hegemony. And with the death of communism, the world could now follow its leader and advance forward in a globalized capitalistic coalition – at least that was the hope.
The downside was that Pax Americana would also come to mean that the economic model of the U.S. would rely on the success of foreign economies. America’s top interest became the consistent hum of the global economy. After all, if the emerging economies of the newly capitalistic world failed, what would that say about the U.S. Cold War victory? For the previous fifty years, the U.S had been preaching its way of life. Now the world was swamped with the newly converted. The problem was the church wasn’t big enough to hold them. The expansion of democracy and capitalism took its priority and the move toward globalization was on.
But after the initial flurry of economic activity from the access to new markets, true wealth creation across the globe started to diminish in the late 1990s. The level of demand was insufficient for the newly created supply. It was then decided that the world’s growth needed fueling from more stimulation of the money supply. Excess demand could be stimulated with debt in the same way that supply had been encouraged. The theory seemed right, but it depended on whether the stimulated demand could be sufficient to absorb global overcapacity without creating credit bubbles. The world’s debt, particularly the West’s, was left to expand astronomically.
Many argue that conventional monetary policy tools have not worked so well in the aftermath of a globalized world with too much production capacity and volatile shifts in demand. Alternatively, some contend that the monetary measures have been extremely successful in healing the economy. They point to the six-year run in the stock market and the lower unemployment rates. But are these accomplishments indication of success? Sure, asset prices have been inflated, but the measures have not yet accomplished their primary objective. They have not spurred sustainable and broad-based economic growth. The world still flirts with recession and crisis and most of the economic benefits of recovery have fallen into the pockets of the wealthy. Meanwhile, the oversupply continues to exert its ever-increasing deflationary force on an already tired and several decades-old economic boom that started post-World War II.
Even with the modicum of success, central bankers have been portrayed as maestros, guiding the world’s economic melody flawlessly through its treacherous course. Surprisingly, the central banks have been able to hold tightly to their appearances of infallibility. But central banks have and will continue to make mistakes and an ultimate reckoning cannot be magically avoided.
Which brings us now to the intended role of the central banks. The central banks perform their best work when supply and demand are relatively anchored. They raise the money supply during those pesky, cyclical recessions and lower it when the economy is overheated. They have worked well as thermostats, regulating the heating and cooling of the economy. The tasks of the central banks are easy when the economy is in the midst of a long productive era with reasonable inflation and marked by a stable structure of supply and demand. As with anything, however, good times must eventually end.
Consistently, as each global productive era begins to taper and the supply-demand structure becomes increasingly unstable, governments and central banks fail to sense the slowdown relating to the end of the grand upswing. They confront the deflationary pressures as a typical pullback within the larger uptrend. In response to failing wealth creation and the risk to the standard of living, governments and central banks answer by increasing money supplies and fostering more and more debt. And when that doesn’t work to jumpstart the economy, they do it again. And again. A tipping point is ultimately reached. Human nature ensures it.
So far, the central banks have been able to reflate the global economy and forestall the greater economic consequences of mounting global deflation. Or have they? The lost decades of the Japanese economy, the Asia Economic Crisis of 1997, the Russian default in 1998, the dot.com bust at the turn of the millennium, the housing boom, the banking crisis, the Greece and the Euro credit crises – all from sustained and massive increases in the money supply. One crisis “averted” while another one caused. And debt bubbles continue to surface, the latest being the oil production bust.
The drama unfolding has been like watching a game of “whack-a-mole.” Bubbles have developed and popped, but still elusive is the anticipated broad-based wealth creation. The central banks, with the help of lawmakers, have repeatedly ended back at square one – reflating the money supply in hopes of spurring sustainable growth only to find the next bubble has formed.
But now with the latest twists of deflation – the recent China slowdown, the depressed price of oil, the geopolitical and regulatory roadblocks, and the tale yet to be fully told on the oil production bust – further economic “normalization” may be a bridge too far for the central banks. Their shots are increasingly less effective and their choices of weapons are dwindling. Plus, the economic recovery is coming at the increasing cost of collateral damage – few can argue that financial inequality has improved under the Fed’s monetarist regime.
The world’s economic situation has caused a race among the world’s central banks to manipulate their own money supplies, interest rates, and currency prices in attempts to shift the effects of growth to within their respective borders causing further imbalances. The U.S., the Euro, Japan, China, and Russia, all are acting and reacting, trying to counter the other’s next potential advantage.
The level of the money supply now prescribed for one economy has become incompatible with objectives pursued by other countries. The monetary balance-of-power is being played out not only in the world’s economies and markets, but its geopolitical arenas as well. Yes, monetary nationalism has made its resurgence over the diminishing share of global economic pie. And frustrations over the dollar are understandably growing. Ask Russia, China, or Saudi Arabia.
It is safe to say the general public has little knowledge or understanding of this situation. Nor is it likely appreciated just how inexact monetary policy really is. Is it an art or science? Lately, it seems the central banks are making best guesses. But as the global economy keeps stubbornly refusing to get back on track – even after the many failed rescue attempts – it begs the question, just how far can monetary measures go towards building a dike against a once-a-century, tsunami-sized wave of persistent global deflation?
The debate over the central banks’ contribution to today’s global imbalances is far from over. As this century moves forward, and with the benefit of hindsight, are future economists going to look back on today’s actions as another failed episode in the centuries-old story of economic depression and man’s inability to control it? Just as each depression-size occurrence of global deflation in the past forced new schools of economic thought, this era’s economic inspiration will also likely earn its own distinction. Someday, it may appropriately be coined, “the Great Monetarism.”
Christopher Petitt is the author of the book, The Crucible of Global War: And the Sequence that is Leading Back to It. It is available for sale at Amazon.com, Barnesandnoble.com and for order at bookstores everywhere.