Several Unsustainable Economic Myths

I would like to conclude with a critical look at several powerful and tiresome economic myths we read and hear about again and again in the newspapers and on television.

The first myth is that the increase in the minimum wage in Spain (from 600 to 900 euros, and eventually to 1,000 or 1,200 euros) is not having a negative effect on employment. All of economic theory shows that rises in the minimum wage do boost unemployment, the underground economy, and the misallocation of the labor factor. Theoretically, the only way such a rise could possibly not have these negative effects would be if the government set the new wage lower than the already freely existing market wage. But in that case, why set one at all? However, that is not the way it works. Moreover, as a result of this change, if, in the constellation of different jobs and wages, there is even one worker whose discounted marginal value product is less than the legal minimum, that will be sufficient to keep that worker from being hired or, if already working, to cause that worker to be let go. Without a doubt, this measure will cause – and is already causing – unemployment and a misallocation of resources (though in economics, changes always take place gradually and at the margin). The very Bank of Spain has published a study in which it predicts that at least 150 thousand jobs will be destroyed, and these are jobs done by the most vulnerable people (young
people just entering the workforce, women, immigrants, etc.). For instance, it is obvious that an immigrant who has, with great difficulty, managed to get his papers in order, is going to have a very hard time finding a job if the cost to the entrepreneur of hiring him is going to be, including social security, over sixteen thousand euros a year (nine hundred euros a month, in fourteen paychecks, plus 30 percent in social security). Nobody is going to hire him! (And clearly, very few families are going to be able to afford to pay sixteen thousand euros a year to the people who care for their elderly members, or to their domestic workers, a sector which, up to now, has employed hundreds of thousands of people.) So, our immigrant will most likely be forced to wander from place to place in the underground economy. The government hypocrisy in this matter is staggering. We welcome everyone (“Refugees welcome!”), but mind you, no one is going to find a job here in the formal economy, because now the minimum wage is 900 euros , and the government plans to raise it to 1,000 and even to 1,200 euros . (And why not raise it to two thousand or even more, if employment will not be affected?).

The second myth I have often commented on is that central banks saved our economies duringthe Great Recession. This is the myth of the arsonist-fireman, for it was precisely central bankers themselves who orchestrated the credit expansion and generated the bubble that later led inexorably to a crisis and a recession. And now they look like the ones responsible for saving the day, because they kept banks from failing. Then again, they saved Bankia, but they allowed the Banco Popular to go under, because it was smaller. They made mistakes, like when they let Lehman Brothers collapse and everything else nearly collapsed with it. Clearly, central bankers have intervened in an irresponsible, ad hoc manner that generates great uncertainty and constant financial instability. The third myth is that quantitative easing was necessary to avoid a deflationary crisis. This is untrue. For instance, the European quantitative easing was unnecessary. When it was initiated in January of 2015, the European M3 was already growing on its own at a rate of 4 percent; that is, at a rate very close to the target of 4.5 percent. Quantitative easing was totally unnecessary, and as I have argued, it has had a very damaging and self-defeating effect and has completely blocked the reforms the Eurozone needed. Even Mario Draghi’s old rhetoric that monetary policy does not replace the necessary structural reforms the different countries must make to meet their Maastricht obligations was, after the quantitative easing, almost totally forgotten and replaced with a desperate request for more fiscal spending. By now, it is so obvious that no one is making structural reforms because the European Central Bank is financing governments for free that it would be hypocritical to keep mentioning such reforms. It is obvious that the ECB has betrayed its founding principles. Ultimately, it is financing the public deficit of all the countries. (Remember that it already owns 30 percent of their outstanding public debt, including Spain’s.) Furthermore, it attempts to stimulate economic growth (like the Fed), when it has authority only to maintain monetary stability. Consequently, the ECB has become a hostage to its own errors, its ultra-lax monetary policy. The moment it announces it is withdrawing this policy, a recession will hit, and no one is willing to deal with it. And if the ECB continues to inject money, it will fully Japanize the Eurozone and sentence it to indefinite lethargy in an environment of constant discord between the members of the governing board, which is already thoroughly politicized.

The fourth myth (or rather, dogma of faith) is that inflation must be less that 2 percent but close to 2 percent. But why? Where did that magical figure come from? It came from mathematical models. All the “experts” locked themselves into a meeting room – the governors of the ECB, the Bank of Japan, the Federal Reserve, the Bank of England, etc. And bingo! They determined the rate should be 2 percent. But why 2 percent? It is a bizarre, totally arbitrary target and one that is very difficult to reach in an environment in which productivity has risen as much as it has at the beginning of this century, as a result of the technological revolution and the introduction of numerous innovations. In this context, 2 percent is an unrealistic goal, and attaining it requires a super-lax monetary policy which causes all of these effects we have discussed. These effects destabilize the economy and the financial world and, as we have seen, they lead to the process of Japanization in rigid economies like ours. A couple of years ago, I was invited to a meeting at the Kiel Institute for the World Economy. The meeting was also attended by, among other experts, a former head economist at the ECB. Well, we eventually arrived at the conclusion that, under the current circumstances, the inflation target should not be 2 percent, but 0 percent, and the reference target for M3 growth should be between 2 and 2.5 percent. If this had been the target, we would have been spared the ultra-lax monetary policy and the Japanization process. And – paradox of paradoxes – very recently, there has been talk of making the target more flexible, but not to suspend the ultra-lax policy (an unnecessary policy when the inflation target is lowered to 0 or 1 percent), but to justify higher inflation rates throughout the cycle (which “compensate for” the prior
downward disparities). What logic!

The fifth myth you will have heard is that the natural rate of interest is falling. What hypocrisy! They artificially lower the interest rate to zero (or even make it negative), and then they argue that the natural rate is dropping! Nobody can observe the natural rate of interest. All that can be observed is the gross interest rate in the credit market. In the absence of coercive intervention, this rate includes the natural rate of interest, premiums for expected inflation or deflation, and risk premiums (and occasionally, in the very short term, a negative liquidity premium). But it is obvious that no one can observe the natural rate of interest. Some people say: “Well, a proxy might be provided by the interest rate on ‘risk-free’ bonds.” One moment! It is precisely risk-free sovereign bonds that you are compulsively buying and generating in their markets a bubble the likes of which had never been seen before! What brazenness and hypocrisy!

The sixth and last myth we are going to discuss is the mantra that interest rates are very low because people are saving a lot and the population is aging. It is said that Japanization is due to the fact that the Japanese population is aging more and more and is saving a great deal. This argument is false and confuses saving with inflation (inflation in the traditional Austrian sense of monetary growth). Benjamin Anderson used to say that according to this argument, the bigger the injection of money, the greater the saving! Of course, money is injected, and people all hold it in their pockets, as we have seen, and then it is argued that people are doing a lot of saving. But no. What is
happening is that there is an increase in the demand for cash balances (stock), which should not be confused with an increase in saving (flow). And as for the aging of the population, that argument is also weak. When people retire, they consume what they had saved before. We must realize that in Japan, the demand for money has increased dramatically, and this increased demand is largely being channeled into government bonds, which are treated as cash. What a time bomb for Japan should the bond markets collapse!

Remember what we have said about these tiresomely repeated myths, so that you can refute them when you hear them even from prestigious minds in our discipline.