“This is the way the world ends; not with a bang or a whimper, but with zombies breaking down the back door.” - Amanda Hocking, Hollowland
A recent poll by VoxEU showed that the majority of the economists have turned against the unorthodox means of the central banks. This is no wonder as the central banks have drifted far from their original tasks, namely to issue bank notes, to guarantee the debt of the sovereign and to act as the piggy bank for the commercial banks. Their mandate never was to destroy the pricing mechanism of the capital market.
The most puzzling thing is the (spurious) lack of understanding about the essence of the capitalist market economy among the central bankers. They, at least publicly, seem to think that, by providing the firms and the consumers with easy credit and by chasing the nearly magical “natural rate of interest”, they make the economy flourish. However, easy credit and the generous asset buying programs diminish the viability and energy of the economy, thus leading to serious long-term consequences.
The idea of the creative destruction, put forth by Joseph Schumpeter some 70 years ago, describes the nature of the business cycle. Economic expansions always breed unproductive investments and the role of the recessions is to release the economy from this burden. The creative destruction is a process of purification that occurs during recessions. That is, a typical business cycle recession promotes a more efficient allocation of capital by driving out bad investments and by releasing resources for new, productive and innovative activities.
However, depressions, especially those caused by economic crises, may create a situation that threatens the credit system. If such a systemic crisis occurs, not just purification but also a pure destruction of productive businesses may take place. It is evident that during the financial crash of 2008 we came very close to such a systemic crisis. The combined actions of central banks and governments averted this. There is no doubt that this was something that needed to be done. Nevertheless, the after-the-crisis actions of the central banks lead us to a dangerous path.
Boom, bust and zombies in Japan
The zero or negative interest rates and the quantitative easing applied currently are not new constructions. Both of them were tried in Japan after her asset and real estate bubbles in the early 1990’s. Before that, Japan enjoyed a long period of economic growth that got into a higher gear in the late 1980’s due to easy credit and speculation. This led to bubbles in asset and real estate markets, the collapse of which led to a long-lasting recession.
After the crisis, Japan decided to save everyone. Ailing banks and companies were kept in operation with aggressive measures by the government and the Bank of Japan (BoJ). The government gave subsidies to firms so that they could maintain employment and banks were allowed to hold non-performing loans in their balance sheets without any pressure to restrict the borrowers’ businesses. BoJ provided cheap credit for the ailing firms, which depressed job creation and production growth. BoJ also purchased long-term government bonds and started the first ever QE in 2001. None of these policies were able to recover the economy of Japan from its malaise. The evidence actually suggests that these exceptional measures made the situation in Japan worse.
Zombie economies do not end well
The major central banks have and are, repeating the mistakes of BoJ on a massive scale. Zero and below-zero interest rates have created a situation, where easy credit is keeping more and more unprofitably firms alive (including the “unicorns”). QE is rising the prices of the high-risk and junk bonds to such levels where the expected profits of these firms are becoming irrelevant. This will misallocate financial capital in an unimaginable scale.
Central banks have thus created a situation in which a large number of firms will fail in the next recession. The large number of zombie businesses can also create a recession if (when) the interest rate rises, leading to insolvencies and bankruptcies. If the recession turns out be a major one, which looks more and more likely, we will have a “zombie apocalypse” implying a global flood of business bankruptcies. Even in the mildest imaginable recession, the zombie businesses created by the central banks will surely worsen the economic fallout.
In his recent column, the renowned economic journalist Martin Wolf goes on the defense for central bankers. He claims that they did their job while the others (banks and governments) did not. But, as explained above, advocating the central bankers and their unorthodox measures, means disregarding historical findings as well as structural macroeconomics. In the long-run we are all dead, but I would like to live my life among the living, not with the zombies threatening to bring down the back door. Wouldn’t you?