Defeating the Right's Favorite
Talking Point for Good
JUL 08, 2019
The Democratic Party has
clearly swung to the progressive left, with candidates in the first round of
presidential debates coming up with one program after another to help the poor,
the disadvantaged and the struggling middle class. Proposals range from a
universal basic income to Medicare for all to a Green New Deal to student debt
forgiveness and free college tuition. The problem, as Stuart
Varney observed on “Fox Business,” is that no one has a viable way to
pay for it all without raising taxes, a hard sell to voters. If robbing Peter
to pay Paul is the only alternative, the proposals will die for lack of
funding—just as Trump’s trillion-dollar infrastructure bill did.
Fortunately, there is another
alternative, one that no one seems to be talking about—at least no one on the
presidential debate stage. In Japan, it is a hot topic; and in China, it is
evidently taken for granted: The government can generate the money it needs
simply by creating it on the books of its own banks. Leaders in China and Japan
recognize that stimulating the economy is not a zero-sum game, in which funds
are just shuffled from one pot to another. To grow the economy and increase the
gross domestic product, demand (money) must go up along with supply. New money
needs to be added to the system; and that is what China and Japan have been
doing, very successfully.
Before the 2008-09 global
banking crisis, China’s GDP increased by an average of 10% per year for 30
years. The money supply increased right along with it, created on the books of
its state-owned banks. Japan under Prime Minister Shinzo Abe has been following
suit, with massive economic stimulus funded by correspondingly massive purchases
of the government’s debt by its central bank, using money simply created with
computer keystrokes.
This has occurred without
driving up prices, the dire result predicted by U.S. economists who subscribe
to classical monetarist theory. In the 20 years from 1998 to 2018, China’s M2
money supply grew from just over 10 trillion yuan to 180 trillion yuan ($11.6
trillion), an 18-fold increase. Yet China closed 2018 with a consumer inflation
rate that was under
2%. Price stability has been maintained because China’s GDP has grown at nearly the
same fast clip, by a factor of 13 over 20 years.
Japanese Prime Minister Abe’s
massive stimulus programs, called “Abenomics,” have been funded through the
Bank of Japan. The central bank has
now “monetized” nearly 50% of the government’s debt, turning it into
new money by purchasing it with yen created on the bank’s books. If the U.S.
Federal Reserve did that, it would own $11 trillion in U.S.
government bonds, four times what it holds now. Yet Japan’s M2 money
supply has not even doubled in 20 years, while the U.S. money supply
has grown by 300%; and
Japan’s inflation rate remains stubbornly below the Bank of Japan’s 2% target.
Abe’s stimulus programs have not driven up prices. In fact, deflation remains a
greater concern than inflation in Japan, despite unprecedented debt
monetization by its central bank.
China’s Economy: A Giant Ponzi
Scheme or a New Economic Model?
Critics have long called
China’s economy a Ponzi scheme, doomed to collapse in the end; and for 40
years it has continued to prove them wrong. According to a June report by the
Congressional Research Service:
Since opening up to foreign
trade and investment and implementing free-market reforms in 1979, China has
been among the world’s fastest-growing economies, with real annual gross
domestic product (GDP) growth averaging 9.5% through 2018, a pace described by
the World Bank as “the fastest sustained expansion by a major economy in
history.” Such growth has enabled China, on average, to double its GDP every
eight years and helped raise an estimated 800 million people out of poverty.
China has become the world’s largest economy (on a purchasing power parity
basis), manufacturer, merchandise trader, and holder of foreign exchange
reserves.
This massive growth has been
funded with credit created on the books of China’s banks, most of which are
state-owned. Even in the U.S., of course, credit is simply created on the books
of banks; that is what
most of our money supply is. The difference is that the Chinese government
can and does intervene to direct where that credit goes. In a July 2018 article
titled “China
Invents a Different Way to Run an Economy,” Noah Smith suggests that
China’s novel approach to macroeconomic stabilization by regulating bank credit
represents a new economic model, one that may hold valuable lessons for
developed economies. He writes:
Many economists would see this
approach as hopelessly ad hoc, haphazard, and interventionist—not the kind of
thing any developed country would want to rely on. And yet, it seems to have
carried China successfully through several crises, while always averting the
catastrophic financial crash that outside observers have been warning about for
years.
Abenomics, Helicopter Money
and Modern Monetary Theory
Smith has also written about
Japan’s unique model. After Abe crushed his opponents in October 2017,
Smith wrote on
Bloomberg News, “Japan’s long-ruling Liberal Democratic Party has figured out a
novel and interesting way to stay in power—govern pragmatically, focus on the
economy and give people what they want.” He said everyone who wanted a job had
one; small and midsize businesses were doing well; and the Bank of Japan’s
unprecedented program of monetary easing had provided easy credit for corporate
restructuring without generating inflation. Abe had also vowed to make both
preschool and college free.
Like China’s economic model,
Abenomics has been called
a Ponzi scheme, funded by central bank-created “free” money. But it is a
strategy that has been working for the economy. Even the once-dubious
International Monetary Fund has declared Abenomics
to be a success.
The Bank of Japan’s
massive bond-buying program has also been called “helicopter
money”—a policy in which the central bank directly finances government
spending by underwriting bonds—and it has been compared to Modern Monetary
Theory (MMT), which similarly posits that the government can spend money into
existence with central bank funding. As Nathan
Lewis wrote in Forbes in February:
In practice, something like
“MMT” has reached a new level of sophistication these days, exemplified by
Japan. This really is modern; but I haven’t seen any “MMT” theorist who can
explain it. The Bank of Japan now holds government bonds amounting to more than
100% of GDP. In other words, the government has managed to finance itself “with
the printing press” to the amount of about 100% of GDP, with no
inflationary consequences. [Emphasis added.]
Japanese officials have
resisted comparisons with both helicopter money and MMT, arguing that Japanese
law does not allow the government to sell its bonds directly to the central
bank. As in the U.S., the government’s bonds must be sold on the open market, a
limitation that also prevents the U.S. government from directly monetizing its
debt. But as Bank of Japan Deputy Governor Kikuo
Iwata observed in a 2013
Reuters article, where the bonds are sold does not matter. What is
important is that the central bank has agreed to buy them, and it is here that
U.S. banking law diverges from the laws of both Japan and China.
Central Banking Asia-style
When the U.S. Treasury sells
bonds on the open market, it can only hope the Fed will buy them. Any attempt
by the president or the legislature to influence Fed policy is considered a
gross interference with the sacrosanct independence of the central bank.
In theory, the central banks
of China and Japan are also independent. Both are members of the Bank for
International Settlements, which stresses the importance of maintaining the
stability of the currency and the independence of the central bank; and both countries
revised their banking laws in the 1990s to better reflect those policies. But
their banking laws still differ in significant ways from those of the U.S.
In Japan, the Bank of Japan is
legally free to set interest rates, but it must
cooperate closely with the Ministry of Finance in setting policy.
Article 4 of the 1997 Bank
of Japan Act says:
The Bank of Japan shall,
taking into account the fact that currency and monetary control is a component
of overall economic policy, always maintain close contact with the government
and exchange views sufficiently, so that its currency and monetary control and
the basic stance of the government’s economic policy shall be mutually
compatible.
Unlike in the U.S., Abe can
negotiate with the head of the central bank to buy the government’s bonds,
ensuring that the debt is in fact turned into new money that will stimulate
domestic economic growth; and he is completely within his legal rights in doing
it.
The leverage of China’s
central government over its central bank is even stronger than the Japanese
prime minister’s. The 1995 Law
of the People’s Republic of China on the People’s Bank of China states:
The People’s Bank of China
shall, under the leadership of the State Council, formulate and implement
monetary policies, guard against and eliminate financial risks, and maintain financial
stability.
The State Council has final
decision-making power on such things as the annual money supply, interest rates
and exchange rates; and it has used this power to stabilize the economy by
directing and regulating the issuance of bank credit, the new Chinese
macroeconomic model that Noah Smith says holds important lessons for us.
The successful six-year run of
Abenomics, along with China’s decades of unprecedented economic growth, have
proven that governments can indeed monetize their debts, expanding the money
supply and stimulating the economy, without driving up consumer prices. The
monetarist theories of U.S. policymakers are obsolete and need to be discarded.
Kyouryoku,
the Japanese word for cooperation, is composed of characters that mean
“together strength”—“stronger by working together.” This is a recognized
principle in Asian culture, and it is an approach we would do well to adopt.
What U.S. presidential candidates from both parties should talk about is how to
modify the law so that Congress, the administration and the central bank can
work together in setting monetary policy, following the approaches successfully
modeled in China and Japan.
