My structural argument is that the power to control the creation of money has moved from central banks to governments. By issuing state guarantees on bank credit during the Covid crisis, governments have effectively taken over the levers to control the creation of money. Of course, the pushback to my prediction was that this was only a temporary emergency measure to combat the effects of the pandemic. But now we have another emergency, with the war in Ukraine and the energy crisis that comes with it.
And by controlling the growth of credit, governments gain an easy way to control and steer the economy?
It’s easy for them in the way that credit guarantees are only a contingent liability on the balance sheet of the state. By telling banks how and where to grant guaranteed loans, governments can direct investment where they want it to, be it energy, projects aimed at reducing inequality, or general investments to combat climate change. By guiding the growth of credit and therefore the growth of money, they can control the nominal growth of the economy.
And given that nominal growth consists of real growth plus inflation, the easiest way to do this is through higher inflation?
Yes. Engineering a higher nominal GDP growth through a higher structural level of inflation is a proven way to get rid of high levels of debt. That’s exactly how many countries, including the US and the UK, got rid of their debt after World War II. Of course nobody will ever say this officially, and most politicians are probably not even aware of this, but pushing nominal growth through a higher dose of inflation is the desired outcome here. Don’t forget that in many Western economies, total debt to GDP is considerably higher today than it was even after World War II.
Who wins?
The government. Did Berlin ask the ECB whether they can create a rescue package? Did any other government ask? No. This is considered emergency finance. No government is asking for permission from the central bank to introduce loan guarantees. They just do it.
You’re saying that central banks are powerless?
They’re impotent. This is a shift of power that cannot be underestimated. Our whole economic system of the past 40 years was built on the assumption that the growth of credit and therefore broad money in the economy was controlled through the level of interest rates – and that central banks controlled interest rates. But now, when governments take control of private credit creation through the banking system by guaranteeing loans, central banks are pushed out of their role. There’s another way of looking at today’s loud, hawkish rhetoric by central banks: Teddy Roosevelt once said that, in terms of foreign policy, one should speak softly and carry a big stick. What does it tell you when central banks speak loudly? Perhaps that they’re not carrying a big stick anymore.
Walk us through how this will play out.
First, governments directly interfere in the banking sector. By issuing credit guarantees, they effectively take control of the creation of broad money and steer investment where they want it to. Then, the government would aim for a consistently high growth rate of money, but not too high. Again, history shows us the pattern: The UK had five big banks after World War II, and at the beginning of each year the government would tell them by what percentage rate their balance sheet should grow that year. By doing this, you can set the growth rate of broad money and nominal GDP. And if you know that your economy is capable of, say, 2% real growth, you know the rest would be filled by inflation. As a third prerequisite you need a domestic investor base that is captured by the regulatory framework and has to buy your government bonds, regardless of their yield. This way, you prevent bond yields from rising above the rate of inflation. All this is in place today, as many insurance companies and pension funds have no choice but to buy government bonds.
You make it sound easy: The government just has to engineer a level of nominal growth and of inflation that is consistently somewhat higher than interest rates in order to shrink the debt to GDP ratio.
Again, this is how it was done after World War II. The crucial thing is that we are moving from a mechanism where bank credit is controlled by interest rates to a quantitative mechanism that is politicised. This is the politicisation of credit.
What tells you that this is in fact happening today?
When I see that we are headed into a significant growth slowdown, even a recession, and bank credit is still growing. The classic definition of a banker used to be that he lends you an umbrella but would take it away at the first sight of rain. Not this time. Banks keep lending, they even reduce their provisions for bad debt. The CFO of Commerzbank was asked about this fact in July, and she said that the government would not allow large debtors to fail. That, to me, was a transformational statement. If you are a banker who believes in private sector credit risk, you stop lending when the economy is headed into a recession. But if you are a banker who believes in government guarantees, you keep lending. This is happening today. Banks keep lending, and nominal GDP will keep growing. That’s why, in nominal terms, we won’t see an economic contraction.
How do you mean that?
Remember I said that financial repression means engineering an inflation rate in the area of 4 to 6% and thereby achieving a nominal GDP growth rate of, say, 6 to 8%, while interest rates are kept at a lower level. Savers won’t like it, but debtors and young people will. People’s wages will rise. Financial repression moves wealth from savers to debtors, and from old to young people. It will allow a lot of investment directed into things that people care about. Just imagine what will happen when we decide to break free from our one-sided addiction of having pretty much everything we consume produced in China. This will mean a huge homeshoring or friendshoring boom, capital investment on a massive scale into the reindustrialisation of our own economies. Well, maybe not so much in Switzerland, but a lot of production could move back to Europe, to Mexico, to the US, even to the UK. We have not had a capex boom since 1994, when China devalued its currency.
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Originally Posted by Xtrema
