How long can low rates last?

The charging of interest on loans is one of the most hated and worst understood concepts in human history. Aristotle claimed that money cannot beget money because it is dead, so charging interest on loans is immoral. Moses’ law forbid Israelis to charge interest on loans to the poor, but the Church interpreted that prohibition according to Aristotle’s economics and made charging interest on loans one of the worst sins that Christians can commit. Aristotle’s writings had almost equal weight with the Bible in many matters until Copernicus and Galileo trashed his astronomy.

But kings, nobility and popes needed to borrow money occasionally in order to keep up their conspicuous consumption, so Jews were allowed to commit the sin of usury. That gave Christians an excuse to persecute them regularly.

The church didn’t reform its economics until the 17th century when theologians from the University of Salamanca abandoned Aristotle for common sense. A letter from John Calvin to a friend on the topic may have helped. Calvin wrote that interest on loans was no different from charging rent on land, which everyone could understand.

Recently, an investing newsletter increased the confusion over interest rates for its readers. It claimed that interest rates have fallen naturally from roughly 50% in 5000 BC. “Fast-forward a bit and we see the Greeks expanded the credit system. In 600 B.C., they paid rates of around 16% in a quickly modernizing monetary system. By 100 B.C., though, a typical loan came with a rate of just 8%. And then things got interesting...”

Japan’s 4th quarter torpedoes Market Monetarism

Japan’s GDP fell 0.4 percent from the third to fourth quarters, which translates into an annual rate of -1.4 percent as it is commonly reported. The shrinkage dealt another blow to Abenomics, the term the press invented for the Prime Minister Shinzo Abe’s economic plan to boost the Japanese economy through massive money printing. Last month, and before the latest data, the central bank of Japan drove interest rates into negative territory in further hopes of jump starting the economy.

"The latest data show that it is difficult to say that the Abe government has achieved of its goal of a 'virtuous cycle' of rising incomes, wages, and investment," said Tobias Harris, political risk analyst at US-based consultancy Teneo. 

"It's getting clearer that Abenomics is a paper tiger," said Seiya Nakajima, chief economist at Office Niwa, a consultancy, referring to Prime Minister Shinzo Abe's policy mix of monetary easing, spending and reform. 

Japan, Europe and mainstream monetary theory are out of gas

When a sailor hits a dead spot where the wind refuses to blow he cays he is “in irons.” Japan’s economy sailed into the irons this past quarter when its GDP declined for the second quarter in a row and officially signaled a recession. GDP fell 0.8% in the third quarter after shrinking 0.7% in the second on an annualized basis. This marks the fourth recession Japan has endured since the global crisis hit in 2008.

Following so soon on the heels of massive stimulus, the recession should strike a death blow to mainstream monetary theory. Abenomics, the economic recovery plan that Prime Minister Shinzo Abe launched in 2012, was the poster child for mainstream monetary theory. Japan would wash away deflation and decline with a torrent of new money.

Central banks as vestigial organs

In his early years Hayek anticipated that the monetary theory of trade cycles, now known as the Austrian business-cycle theory (ABCT) would become widely known by business people who would refuse to borrow when the central bank reduced interest rates to an artificially low level. That would dampen booms caused by money created ex nihilo and reduce the severity of recessions.

Hayek was wrong because the Keynesian tsunami pushed the ABCT into a tiny corner so that few business people learned it. However, we may have reached a similar dampening of economic cycles by another route, that is, by central bankers making central banking irrelevant. Glimpses of this can be seen in Japan, as I wrote in this posting.

Abe Channels Hoover

Japanese Prime Minister Shinzo Abe recently vowed to press companies to raise wages. His vow should have set off alarms among economists. Instead it elicited applause. The irony is thick but only economic historians and Austrian economists can appreciate it. Even the financial press missed it.

The irony lies in the fact that the first thing US President Herbert Hoover did when he discerned the approaching disaster of the Great Depression was to employ the persuasive power of his office to convince employers to refrain from cutting wages and attempt to raise them. The Wall Street Journal of December 16, page A11, quoted Mr. Abe saying,

As I toured the nation during the election,  I heard the opinions of ordinary citizens who are suffering from price increases and small-business owners in difficulties due to price hikes in raw materials.”

Abenomics' big fail and the sinking of the rising sun

Economists predicted a 2.25% gain in Japan’s GDP after the 7.3% fall in the second quarter. As usual, they missed it again. Japanese GDP fell 1.6% last quarter according to initial estimates. Mainstream economics’ theory of business cycles states that such downturns in the economy are random events, shocks to equilibrium. As the London School of Economics told the Queen, they had successfully predicted that no one can predict the onset of the worst recession since the great one. Still, they crank out GDP forecasts as if they could predict a recession. They irony is huge, but apparently unnoticed by most of the profession.

However, the most important part of the story was that Prime Minister Abe has been conducting a major monetary policy experiment. He promised to boost nominal GDP and achieve a minimum inflation of 2% by printing as much money as was necessary. No limits. Paleo-Keynesians like Paul Krugman were giddy. 

Abe also promised to reduce the deficit through tax increases and reform the structure of the economy. Partly as a result, the Japanese stock market climbed 55% and the value of the Yen fell 25% in 2013.