Accepted wisdom out the window as government takes control

The RBA is targeting a three-year bond rate of 0.25 per cent, but it’s effectively unlimited QE

There have been so many certainty-shattering developments since the arrival of The Virus that it’s a job to find something solid to hang on to in the cyclone.

The coronavirus is laying waste to ideas that have been the basis of Western civilisation since democratic capitalism won World War II and then, 26 years later, the monetary system was freed from being tied to gold.

For a start, globalisation, if not dead, is in intensive care with the COVID-19 patients: the pandemic has exposed undreamt of fragilities in the international trading system that created so much wealth and seemed so indestructible.

Second, markets that had been floating on easy money, more or less oblivious to the real economy, have been crushed by the real economy, suddenly oblivious to the easy money.

True, the Dow Jones had its biggest day since 1933 this week and followed up with two more rises in a row after the Fed unveiled infinite quantitative easing, but this week’s bounce has more to do with the $US2bn ($3.3bn) fiscal stimulus, plus portfolio rebalancing and short covering, than any renewed conviction based on the Fed.

But perhaps the greatest certainty to have been shattered is the restraints on government in a free economy.

Ronald Reagan’s declaration in his 1981 inaugural address that “government is not the solution to our problem, government is the problem” has more or less formed the basis of conventional politics and economic policy ever since. The need to limit government debt, lower taxes and reduce red tape and bureaucracy has been the foundation of policy for three ­decades.

Now government, and government-funded science, is most definitely the solution to our problem, and politicians and bureaucrats are trampling the private sector into the dust as they try to “flatten the curve” of infections.

To some extent they are confronting the result of decades of pressure on government budgets which has resulted in limited hospital beds, although it’s doubtful that even the best-funded healthcare system could withstand a global pandemic like this.

But horror at potentially having to ration lifesaving equipment and choose who lives and who dies is producing the most forceful government intervention in Western economies since World War II.

The shift to government control has been swift, absolute and, it must be said, patchy in its quality. The corporations that had been running the economy are simply being shut down or turned into mendicants.

The most powerful limitation on the size and power of government since the Reagan inauguration has been the idea that deficits and public debt are bad and surpluses good, and that government spending should be funded by taxes. That has now been ­entirely ditched.

(Ironically the greatest exponents of deficits and debt in the US have been the Republicans, including Reagan himself, not to mention the incumbent, but that’s another story.)

Last Monday I wrote a column here to the effect that “Modern Monetary Theory’s time has come”, in which I argued that governments would have to adopt MMT, in which deficits would be funded with printed money, as in quantitative easing, because there will be too much new debt for the market to swallow.

Well, the founder of MMT contacted me this week to explain that I had got it wrong: MMT is not a policy that a government can adopt, it is a lens through which we can see how the monetary system actually works, he said.

Bill Mitchell is professor of economics at the University of Newcastle and, along with an American hedge fund manager named Warren Mosler, he invented the idea of MMT in the 1990s and gave it the name. Now, suddenly, everyone’s talking about MMT and Bill Mitchell is in demand. I had a long conversation with Bill this week during which he put me straight.

Some $US20 trillion of money has been brought into existence since the GFC by the Federal Reserve, the Bank of Japan, the ECB and the People’s Bank of China.

The money has been mainly used to buy government bonds, although the BoJ has been buying stocks as well. The assets purchased sit on their bloated balance sheets, and the conventional wisdom has been that the central banks will sell them back into the market at some point, in a process called quantitative tightening. The Fed already started that, but had to stop after the 2018 correction and start buying again when money markets had a conniption last year.

Will the bonds owned by central banks ever be sold back to the markets now? No, of course not. In fact all central banks, including the Reserve Bank of Australia, are now doing QE to infinity, and have made sure everyone knows it. The RBA’s version is to target a three-year bond rate of 0.25 per cent, but it’s effectively unlimited QE.

Eventually the bonds so bought will mature and have to be repaid. As Professor Mitchell told me: “In that case, it’s sort of like the right pocket giving the left pocket some money. It’s an internal government transfer. It’s just an accounting transfer.”

In other words the debt, and therefore the coronavirus stimulus, will have been monetised — the bonds cancelled like shares in a corporate buyback — and MMT will have happened, or rather been the lens through which we can view it.

Professor Mitchell’s theory, put simply, is that the only limit on the spending of a sovereign government that issues its own money is not financial, but economic — the supply constraints in the economy. A government can create any amount of money it wants: inflation will only happen if there is a shortage of labour or goods that drives prices higher.

Those limits don’t apply now. Unemployment is about to pass 10 per cent and output is shrinking, dramatically. Enormous spare ­capacity is opening up.

Any amount of government spending to rescue the crashing economy, caused by the efforts to control the virus, could be paid for by the Reserve Bank simply transferring (newly created) cash to the right state or federal government department to spend, rather than buying the bonds later and then cancelling them.

But we don’t want to do that ­because we don’t trust politicians. They need to be handcuffed by the idea that all spending must be funded by taxes or debt. Otherwise where would we be? In the land of the Magic Pudding, that’s where.

But that is a fabrication ­designed to prevent politicians using unlimited cash to buy votes and entrench themselves in power.

The interesting question now is whether that fabrication will survive the virus or become one of its casualties.

Alan Kohler is the editor in chief of eurekareport.com.au