Wednesday, July 8, 2015

Desperate Effort and the Philosophy of “Whatever It Takes”

For a Reuters business headline, it has a surprising degree of existential angst:

The story examines separate attempts to push monetary policy beyond its limits in the eurozone and China. “Whatever it takes” is the familiar phrase famously used by the head of the euro to characterize the efforts of the European Central Bank to preserve the currency union. It is hard to say “whatever it takes” in any context without irony, but especially so in the area of monetary policy. Economists who have made a special study of money will be the first to tell you that there are many things money simply can’t do, no matter how precisely and professionally it might be managed.

In Europe, of course, there is the open question of whether the flow of money from the central bank is enough to keep the banks in Greece afloat. When there is even a moderate degree of public eagerness to move money out of a country perceived as troubled, adding more money to the country simply results in faster outflows. We see this in Greece, where people lining up to draw €60 from the ATMs are, in most cases, not spending the money that day or that month, but saving it for future months. To the extent that they are able to, many are depositing the cash in banks that they consider safer. Obviously, the banks of choice at this point are banks operating in countries other than Greece. Raising the daily limit would not calm these depositors, except in the sense that eventually the accounts would be empty.

An inflationary monetary policy would go a short distance toward easing the financial pressure on Greece, but when Mario Draghi said “whatever it takes” in 2012, he didn’t mean to imply that the ECB would go that far.

“Whatever it takes” is a peculiar philosophy in the best of times. Originally it implied any degree of personal initiative and effort that would achieve a specific result, but it doesn’t take long to discover that initiative and effort won’t get a person past even ordinary obstacles, so the meaning of “whatever it takes” tends to get expanded as you go along. This approach, if you adhere to it, inevitably leads to success or an existential crisis — often, both. The existential dilemma is most famously stated as “God is dead,” but for philosophical purposes, you could just as well say, “Individual initiative is all a lie,” or “Extreme emergency monetary measures won’t restore public confidence.” It’s all the same thing.

Some of the limits of monetary policy have been known all along. “You can’t push on a string” is the colloquial way of explaining why lowering interest rates from 4 percent to 0 percent fails to create any additional net economic stimulus. In truth, money policy has very few instruments at its disposal and is starkly limited in what it can hope to accomplish.

These limits are abundantly clear in the breakdown in China. There, the central bank, regulators, and central government policymakers are working together to try to restore confidence in the stock market. Having already pushed too far by encouraging individual stock investors to borrow huge sums of money to buy stocks, the government finds itself with little leverage left to slow down a stock market crash. Today it is said that half of the stocks in China were halted — trading was stopped in those stocks after they fell the maximum amount allowed in a single trading day. Traders responded by selling the stocks that remained, including solid companies that in theory shouldn’t be affected in market fluctuations. The result of the policy intervention at the end of the day is the widespread feeling is that the whole market is going down.

The week started with an extraordinary show of support for the stock market. The central bank made loans directly to brokers with the instruction to find investors who would be willing to borrow the money and buy specific troubled stocks that the central bank wanted to support. That stabilized the market for two days, but at what cost? The loans are legally dubious to begin with, and they give the impression that the government has thrown ethics out the window in a desperate attempt to prop up a faltering economy, hardly a way to reassure the public. To illustrate the ethical problems with this approach, imagine the fate of an individual investor who took one of the central bank loans and entered the market on Monday. Tonight the investor is down 10 percent in an investment made with 90 percent borrowed money. The investor’s life savings, more or less, got wiped out in two days. It is a high social cost, impossible to defend for a strategy that had a low probability of success to begin with.

Historically, such a bold stock market intervention would be saved for the end of a crash, when stock prices had fallen to 5-year-lows. For China to attempt such an intervention so early implies that the central government is worried that everything is falling apart. That lack of confidence is part of the original problem. The stock market crash and general economic slowdown in China really could bring down the government, just as the crisis in Greece has brought down a series of governments there, but by responding out of desperation, the government in China has only underscored its fundamental lack of confidence.

The “whatever it takes” philosophy seeks to replace desperation with desperate effort in the hope that the results will be better. Unfortunately, desperation doesn’t necessarily increase the chance of good results. In Europe, for all the extraordinary efforts being put forth there, the situation still looks alarmingly similar to no one doing anything at all. The desperate efforts, so far, are going for nothing. Things look more serious in China. Desperate efforts there have only succeeded in adding fireworks to the fire.