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Governments and central banks are pursuing policies that will only exacerbate economic and social problems. That's what professor and former central banker Lex Hoogduin says in conversation with Paul Buitink of Holland Gold. For far too long, central banks have pursued an accommodative monetary policy, causing inflation to spiral out of control and allowing governments to spend more money. As a result, all discipline with regard to budgetary policy has disappeared. He also sees that the government is taking an increasingly important role in steering the economy, which means that the free market is less and less able to function properly.
According to Hoogduin, central banks have contributed to imbalances in the economy with their interest rate policy. "If you set interest rates too low, you ensure that no capital is freed up for things that you want to give the highest priority to. Human capital will then remain tied up in less profitable capacity." According to him, this leads to the maintenance of zombie companies, companies that hardly make a profit and can only survive with low interest rates. Higher interest rates solve this problem, because unprofitable companies disappear and production resources are freed up for companies that are still profitable. In the end, we all benefit from that.
The fact that central banks have kept interest rates low for so long is because they have been aiming for 2% inflation for years. The anchor became price stability and sound monetary policy. "That seemed to work because of a drop in consumer prices, but in the meantime the financial system grew with ever-increasing debt, larger bank balance sheets and increasing government debt. So the underlying anchor had been dragging for a long time.", Hoogduin concludes. And we are now seeing the consequences of that.
According to the former central banker, there is no longer any question of a conservative attitude at central banks today. Discipline is not maintained, the boundaries are stretched to the maximum. An example of this is the announcement of the new TPI Program by the ECB. Hoogduin foresees major problems with this instrument: "The central bank has arrogated to itself the right to determine whether interest rate differentials are the result of market fundamentals or speculation. That is an impossible position, because it will decide whether the fiscal policy is correct or not. In a democratic state governed by the rule of law, that role should not lie with the central bank."
The question of the extent to which the money supply should move with the economy dates back to the 19th century, but is again topical today. According to the classic Currency School the money supply must be rigid, while the Banking School prescribes that the supply of money must move fully in line with the demand for credit.
Under the gold standard, the Currency School, based on the idea that prices always adjust automatically to the money supply and the size of the economy. After letting go of gold's anchor within the Bretton Woods monetary system, central banks tried to regulate the money supply. However, this has been distorted by the development of the Offshore dollar market from the 1950s onwards and all kinds of financial innovations that followed. As a result, the money supply grew out of sight of central banks.
Because central banks could no longer regulate the money supply, they sought a new point of reference, namely the pursuit of price stability. That seemed to work in a world where the economy was growing and inflation was low, but now that strategy is no longer working. Central banks therefore do not have a concrete target point to regulate the money supply.
Is a return to gold the solution? According to Hoogduin, this is also difficult, because our society and all institutions are not set up for this. Today, people would no longer accept it on principle if their salaries were to fall. "A gold standard with a rigid money supply can only work if prices and wages are allowed to move flexibly and thus fall. That is difficult to achieve in today's world. We've created institutions that have taken away this downward flexibility."
According to Hoogduin, government policy is linked by interventionism. 'We have to take control' is a popular term in The Hague. And many of the current policies will ultimately fail to deliver what they are intended to achieve. "Rent caps exacerbate the housing shortage, hold back investments in maintenance and worsen the relationship between tenant and landlord." With regard to climate policy, we see the same thing happening, according to Hoogduin: "This has been given a high priority, so a lot of investments are going into it. This removes capital goods from the rest of the economy, which are then no longer available to citizens. If purchasing power decreases as a result, it is a direct consequence of the policy. And then the government is going to compensate for a problem that it has caused itself."
According to Hoogduin, the big problem is that there is insufficient knowledge in the government about how markets work. As a result, structurally wrong diagnoses are made and wrong decisions are made. "The fact is that the Dutch economy is overstrained and that the response is expansionary monetary and fiscal policy. The budget is getting out of hand and there is no longer any discipline at the Ministry of Finance. Within the government, but also in the opposition. They are only adding more fuel to the fire by currently demanding even more compensation schemes."
Price manipulation by the government obscures the real scarcity in the economy. This will boost inflation and disrupt the economy. Hoogduin: "You take away the price signal. We are now seeing shortages in the economy on all sides, so that includes a restrictive policy. So you have to cut back now, but what they are doing is compensating more people and investing even more in climate policy and defence."
To deal with the disruption caused by these policies, the government will eventually impose more bans, obligations and even rationing. For example, it is now popular to nationalise energy companies and set rent caps on the housing market, but the result is that investments in these sectors are not forthcoming and the scarcity will only increase.
Hoogduin: "The moment the government says it knows better than the market how to allocate capital, it will set prices at different levels than equilibrium prices. Then you get shortages and that goes from bad to worse. The Austrian school of economics predicts exactly what will happen next. That is the tragedy of our time. If you look at it through this lens, you can see that the government is making exactly the wrong decisions."
According to Hoogduin, European countries should be given the option to remain within the EU, but leave the currency union. Nor should countries be forced to adopt the euro. Sweden and Poland are already doing that de facto, so that is possible. "Finally, it must be stipulated that when countries get into trouble with the budget, they go to the IMF. The costs of a fiscal union run into hundreds of billions, for the Netherlands alone. The population must be aware that it is not free."
Hoogduin is therefore very concerned about monetary and fiscal policy. As the Netherlands, we would be making a big mistake by following in the footsteps of Italy and France with large stimulus programmes. It must become clear to the Dutch voter that bringing down inflation has the highest priority. "This pain will not go away with support measures that should restore purchasing power, because they do not eliminate inflation. It's a fiscal policy that gets in the way of the economy, because we're stuck with inflation for longer and then the pain ends up getting even greater."
