It’s Time for Massive Government Spending to Avert a Coming Economic Crisis
By Avi Tiomkin
The global economy is contracting, and deflationary trends are growing stronger. Left unchecked, they will lead to an economic, political, and social crisis, and the breakdown of frameworks carefully constructed over the past 100 years.
To forestall this looming crisis, policy makers must take steps that run counter to economic orthodoxy and prevailing practices. The required course of action involves massive government spending and higher interest rates. A failure to act could have disastrous consequences, leading to social mayhem.
The primary cause of the deflationary process of the past decade is expansionary monetary policy and ultralow (and negative) interest rates. In modern times, monetary policy has been the main instrument used to fight recessions, including the Great Recession that followed the financial crisis of 2008. Central banks lowered rates and infused capital into the markets, but this strategy has exhausted its usefulness and should no longer be applied.
Near-zero or negative interest rates, now popular throughout the developed world, not only fail to contribute to healthy economic activity but also are causing omnipresent damages. A global environment replete with energy surpluses and an almost unlimited workforce, complemented by expansionary monetary policy, increases supply, not demand, in the world.
Moreover, low rates lead to increased savings and reduce consumption, on which the economy depends. Demographics play a role here: The older the world population gets, the more it needs to expand savings as a substitute for diminished income generated by lower interest. Japan, with its aging population and negative rates, is a paramount example of this.
Today, negative interest rates exist throughout the developed world, with the exception of the U.S., although U.S. government bond rates are headed in that direction. While the U.S. economy continues to grow, further downward pressure on rates could cause a sharp decline in household consumption, as has happened elsewhere.
Savings and consumption habits don’t change overnight. The effect of zero or negative rates on consumer decision-making is likely to begin expressing itself in the next year or two, as bonds with long-term yields of 3%, on average, mature and are cashed in. At that point, zero-interest bonds could take their place in the savings cycle. When that happens, a decrease in spending and an increase in savings will inevitably occur.
More immediately, low and negative rates are harming banks, pension funds, and insurance companies, which can’t generate needed profits on invested capital. An index of European bank stocks has fallen almost 60% since early 2018, and stands below 2008-09 levels. Japan’s bank-stock index is down more than 40%, and U.S. banks trade at levels of almost two years ago, notwithstanding an estimated $100 billion of stock buybacks in the past two to three years.
If low rates are a bane to bankers and savers, they have been a boon to other corporations buying back stock and engaging in mergers and acquisitions. Since 2008, companies collectively have spent almost $25 trillion on buybacks and M&A. But companies have diverted and often exhausted their liquidity to buy in their own stock and do deals, skimping on research and development and business investment. Worse, many have borrowed heavily to fund these activities, which tend to destroy more value than they create.
In the case of buybacks and M&A, low interest rates have distorted economic considerations and turned Excel spreadsheets upside down. The distortion is based on the premise that the world economy is still expanding and that inflation persists, albeit at low levels. Not only is this premise wrong, but so are the explanations used by CEOs and boards to justify the policies.
The European economy offers the best example of how accommodative monetary policy and deflationary trends converge in a dangerous way. Following several years and nearly four trillion euros ($4.4 trillion) of monetary expansion, and negative interest rates, Europe now finds itself on the verge of a recession and a potential political crisis.
Persistent deflation, economic weakness, and inequality fomented by a low-rate regime invariably lead to political and social extremism. To stem and reverse these trends, governments, led by the U.S., the European Union, and the United Kingdom, must increase spending aggressively in the next few years to spur growth, directing outlays to infrastructure and public services, defense, domestic security, and more. Old and supposedly sacrosanct budget-deficit ratios—limiting budget deficits to 3% of gross domestic product, for instance—must be ignored. They are archaic and detrimental in light of today’s reality.
Practically, this means monetizing government debt, or flooding the market with government bonds that central banks will buy. By definition, excess supply of bonds should push long-term interest rates higher. Simultaneously, central banks should provide the commercial banking system with direct credit, which will be funneled to households
Governments also should place regulatory limits on stock buybacks and mergers, or impose taxes to deter such antigrowth activities.
It is important to recognize an inconvenient truth: The 2008 crisis never ended, and its impact hasn’t abated. Whether we like it or not, governments and central banks are the de facto solution. Without taking the necessary, if unorthodox, steps described here, economic, social, and political collapse are a near certainty, likely to manifest in the not-too-distant future.
Avi Tiomkin is an adviser to hedge funds. He previously managed money for several large hedge funds and specializes in global macroeconomic analysis.
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