The creators of bubble economies must be made to pay for their sins
Andy Xie says the central bankers and officials who tolerated, even encouraged, the bubbles that set economies up for a crash should answer for their disastrous monetary policies
The US Federal Reserve decided not to raise interest rates in September, nearly a year after its first increase since 2008. While it argued it took no action because of low inflation expectations and low economic growth, it is really about bubbles.
Since 2008, US household wealth has risen by US$6 for each dollar increase in nominal gross domestic product. The current level of household net wealth is 4.8 times GDP, higher than in 2000 or 2008, when the previous two bubbles burst. The Fed is scared that the same could happen now if it raises interest rates. But, if the rate is never raised, will the bubble last forever?
The Fed has been nursing a bubble economy for two decades. When Alan Greenspan mused over irrational exuberance, the Fed was still shy about running a bubble economy. But, when the Nasdaq took off in 1999, he let rip. After the internet bubble burst, he tolerated the rise of a property bubble.
His successor, Ben Bernanke, watched over asset inflation in stocks, bonds and properties. The Fed is now explicit about running a bubble economy. It often quotes the magnitude of the increase in household wealth as a leading indicator for growth down the road. Unfortunately, in three cycles of bubbles, the linkage between asset markets and growth has become weaker and weaker. The Fed is puzzled by this and is still waiting for a growth boom after an increase in wealth of nearly twice the GDP.
The US has become a bubble economy because its monetary policy accommodates the forced savings in East Asia. The rise of East Asia is based on its labour productivity. However, its policymakers have tried to juice the growth through forced savings to maximise investment. Net savings in East Asia are probably over 10 times those in America, with about the same GDP.
The Fed’s accommodative policy and East Asia’s forced savings have led to global bubbles again and again. But, the bubbles have very different long-term consequences in the East and the West. Bubbles lead to overinvestment in the East but overconsumption in the West.
Western central banks keep waiting for an investment boom after cutting interest rates, but it never comes. Global companies understand where capital formation should happen – in East Asia, where capital and labour are much cheaper. As investment doesn’t happen in the West, its wages become stagnant. Thus, East Asia’s export model runs into a wall, and its forced savings become overcapacity, resulting in horrific capital destruction. The world is stuck in a vicious cycle, with decapitalisation in the West and capital destruction in the East.
The ultimate solution to the world’s conundrum is for East Asia to abandon forced savings. That day is likely to be very far off. After two decades of stagnation and deflation, Japan’s gross capital formation is down to 21 per cent of GDP from 30 per cent in the booming 1980s. It is still much higher than the 15 per cent in the US. China is starting at about half of GDP in fixed investment. Without major political changes, it would take decades for it to come down to 20 per cent. The global economy would be out of balance in the meantime.
The Fed has been taking the path of least resistance, hoping that bubbles would lead to a virtuous cycle of investment and wage growth. Instead, it has led the US economy and much of the world down the path of bubbles and rising inequality. In a bubble, a few sharp cookies take the credulous masses to the cleaners.
As bubble economies recur again and again, fewer and fewer people have the chips to play. The froth becomes concentrated. The Fed’s policy is a major factor in rising income and wealth inequality.
The current cycle has run for eight years now, about the same length of time as the previous two cycles. The world is due for another financial crisis.
When it occurs, will the central bankers who have stoked, or at least tolerated, the bubble be held accountable?
People still complain that the bankers who caused the crisis in 2008 got away with murder. But the central bankers and other regulators were equally culpable. They supplied the banks with the weapons and ammunition to carry out the destruction.
Their culpability in this cycle is more obvious. No major economy has deleveraged since 2008. Some, like China, have leveraged up rapidly, contrary to the lessons from the crisis.
We accuse financial professionals of playing with other people’s money and, hence, reckless behaviour. Economic policymakers seem to have the same incentive. They are not held accountable for their decisions that affect everyone’s lives. Even if they wreck the economy, they will go on to earn lots of money for being important.
This is why politics is becoming more volatile everywhere. The world needs a new governance system. Policymakers must be held responsible for their decisions. In the feudal era, kings would chop the heads off ministers who failed them. We need something comparable in the 21st century.
Andy Xie is an independent economist