March 17, 2015

Martin Wolf, bank regulators hindered savings from reaching investment projects… and so secular stagnation resulted.

Sir, Martin Wolf asks and answers: “Why are interest rates so low? The best answer is that the advanced countries are still in a “managed depression”. This malady is deep. It will not end soon.”, “Strong currents that keep rates down” March 18.

And Wolf argues: “The most plausible explanation [for what] Lawrence Summers… has labelled the forces “secular stagnation” — by which is meant a tendency towards chronically deficient demand… lies in a glut of savings and a dearth of good investment projects”.

No Wolf! There are indeed a glut of savings but the reason for the “dearth of good investment projects” is that the savings are hindered from reaching the prime drivers of investment projects, SMEs and entrepreneurs; because bank regulators considered them too risky, and favored bank credit to go where it was perceived as safe.

In 1988 regulators launched the Basel Accord. In it, if banks lent to the government, so that some bureaucrats were to decide how to allocate those resources, the banks needed to hold cero equity.

But, if banks lent that money to some SMEs and entrepreneurs, so that these were given a chance tried to come up with growth, then banks needed to hold 8 percent in equity.

Could the explanation be any clearer? Of course banks stopped lending to “the risky” because “the safe” suddenly provided them with much higher risk adjusted returns.

So when Wolf writes: Ultra-low interest rates are not a plot by central bankers. They are a consequence of contractionary forces in the world economy” it just shows that he still cannot understand what contractionary forces can be powered by means of regulatory risk-aversion.

Wolf holds “We should view central banks not as masters of the world economy, but as apes on a treadmill” Indeed, but what to do when central bankers act like masters of the universe?