Inflated Expectations

Having thus far given his platform almost exclusively over to a Moody’s-mollifying PR campaign regarding ‘austerity’, British PM David Cameron this week decided that the political interests of his curate’s egg of a government might henceforth be best served by dishing up a few helpings of optimism instead.

Not that the announced budget cuts are yet set in stone (or, indeed, that they wholly consist of actual reductions in outlays rather than of slower increases in them).  Not that the first signs of extra spending have already begun to materialize either, with more boondoggles for the green rent seekers already pledged, among other sweeteners promised.

Here indulge us in penning a note to the elite: to chop off a man’s right leg before bunging a few quid at an otherwise loss-making producer of prosthetic limbs so that the poor unfortunate may regain some semblance of mobility, in truth does little to improve the victim’s overall well-being.

Similarly, to force sub-marginal, ‘alternative energy’ projects onto an already cash-strapped electorate  – adding further to business costs outside the privileged circle of the GEs and the Gamesas, as you do  – is similarly no cure for the currently perceived lack of remunerative outlets for either capital or labour.

Sadly, one is too cynical of the political inertia and too aware of the shared dogmas of managerialism involved to be very surprised by the fact that the uncertain new ‘Ins’ only represent a difference in degree, not in one kind, from the corrupted old ‘Outs’ – a world-weariness which may be the consequence of too hearty a mental diet of H.L. Mencken and Albert Jay Nock, perhaps.

But, if not the delivery of further, ill-designed government interventions, what is the answer to our present impasse, you may ask?

In answer, let us start by noting that, as usual, all the focus has been on the macro perspective, on planning (even planning the de-planning!), on top-down. Thus, what has become lost is the fact that while wealth is created one investment at a time and employment one job at a time, those in power can destroy both with the stroke of a pen, and forge the chains to remove the liberty to respond to one’s needs in one single act of legislative tyranny.

The UK – and it is by no means alone in this – needs to get as much harsh medicine in place NOW so that the surviving, potentially viable entrepreneurs have access to the greatest range of well-priced resources – absent their pre-emption by soft-budget, zombie, wards-of-the-state – and so that they can take comfort in thinking that nothing much worse can happen if they do choose to risk their capital in any new investment project.

Similarly, the sooner the realisation dawns that wealth has been lost in the boom and that there are no more Brownite, no-money-down, nothing-to-pay-till-the-next-election ‘free’ lunches, the sooner people will resign themselves to getting on with rebuilding their lives and so with creating more markets, more sources of income, and hence more jobs, for one another.

Despite all the hoopla, a great opportunity has also been missed to shrink other undesirable aspects of the state. Though the emphasis is partly understandable in light of the nation’s dreadful indebtedness, the restoration of prosperity is not just about trimming its grossly swollen budget, but also depends on remedying the UK’s appalling lack of international competitiveness. Red tape should be slashed, bureaucratic meddling abjured, and taxes simplified so that many of the added costs of doing business (which actually amount to more than an interest rate charge, Mr. Osborne!) can be crushed. By all means, let the politicos dress this up with the spin it is intended to benefit the small businessman rather than the corporate fat cats for, in truth, the former, for reasons of fixed costs, limited resources, and lesser economies of scale, will undoubtedly benefit more than the latter.

Though it may have seemed a jolly good wheeze in some party-office, focus-group preview, neither did the Canadian idea of asking the public where any cuts should fall go nearly far enough.

What the new team should have said was: “You – the private sector worker – you pay for all of our services, so which ones could you do without – or  would you rather buy for yourself on the free market –  if we give you back the money we have been confiscating from you to provide them.” Then, taxes could have been slashed as much as possible – so restoring confidence and encouraging self-reliance – as well as allowing spending to be reduced again as the sprawling, poorly-cultivated acres of the Soviet Collective welfare farms were handed back to the hardy, enterprising Kulaks who used to own them (A little debt-for-equity crash privatisation would not hurt here, either, wherever useful assets can be identified for sale to private enterprisers).

To mount a particular hobby-horse of your author’s, I also suggest we end the illusion that public sector workers pay any actual tax out of a wage that has its source in the depredations seized from their forced benefactors in the private sector. In future, state employees should receive a non-deductible salary equivalent to whatever their net pay amounts to today after that whole Magic Circle misdirection of notionally putting more in and taking some back out has been undertaken.

In addition to cutting down on all the unnecessary administrative costs involved in such fiscal prestidigitation, it would make the recipients much more conscious of the fact that they owe the rest of the population their living and it would also open everyone else’s eyes to the fact that they are not dealing exclusively with Angels, Heroes, self-effacing Public Servants, and other ‘frontline’ St. Francises of Assisi, but with people who are often monopolists, rent seekers, busybodies, and feather-bedders; people with whom it is very hard to dispense and whose role is often utterly counter-productive in that they are paid – with very little threat of meeting any real test of their value added such as private workers must daily face – to sit around thinking up new rules, regulations, agitprop campaigns, and Cultural Marxist initiatives with which to plague their defenceless fellow citizens in both their personal and professional lives.

Ultimately what this amounts to is that the only piece of legislation needed to make up the next Queen’s Speech is that, henceforth, all other edicts shall be subject to Say’s Law and that the state will be content, henceforth, to act as referee in that law’s demand for economic flexibility and will no longer presume to play the role of coach, captain, and corner-kicker, too!

Above and beyond this, let us be clear that whatever our central banking patent medicine peddlers may say to the contrary, we do not need any more inflation to confuse the issue. The supply of money is stable enough and its rate of circulation sufficiently brisk to obviate the need for further emergency transfusions, so let’s get on with adjusting prices so they clear, not camouflaging them even more so we can deny that they don’t.

That this needs to be said at all is testimony to an intellectual miasma surrounding this issue which has become well-nigh impenetrable, thanks to the utter insanity of today’s dominant creed of DSGE macromancy.

For example, while Posen, Bernanke and their ilk continue to harp on the theme that lower real interest rates can be ‘stimulative’ – though stimulative of what, precisely, they are inherently unable to foretell – they also totally disregard the fact that naturally lowered real rates are a result, not a precursor, of economic advance, while artificially induced ones lie at the root of all our current woes.

But in a self-immolating exercise in reductio ad absurdum, this superficial reasoning has led the Fed right up against the so-called ‘zero-bound’ in nominal rates (one which a dedicated inflationist could, in any case, make a great deal less constraining if ~$1 trillion in excess bank reserves did not accrue positive interest). Ergo, the only way the Doves feel they can deliver more ‘stimulus’ via lower real rates is (a) to force down yields at longer and longer maturities – and rational capital allocation and return on invested income, go hang! – or (b) to push up either the rate of price appreciation itself or, at the least, expectations thereof. Nominal rates down and/or prices up ≡ real rates down –» spending up is the alpha and omega of their plan.

This last has even been taken to the ludicrous extremes that an FRB discussion paper last month, entitled ‘Oil shocks and the Zero Bound, purports to argue that while higher oil prices normally lower output by pushing up inflation, once under conditions of ZIRP, the higher oil price raises inflation expectations, reduces the prospective real interest rate, and therefore stimulates the interest-rate sensitive parts of the economy!!!!

Oh, Brave New World! Here we are supposed to concur in the notion that a man whose job is at risk because his employer can no longer afford the dearer diesel he needs to run the factory, and whose commute to that work has suddenly become that much more expensive, too, will be inspired both by this heightened anxiety for his livelihood, as well as by his shrunken disposable cash flow, to take out a loan – which he would otherwise never have countenanced contracting – in order to buy a newly-built house at his lower real yield!!!

Additionally, in this Bread from Stones scenario, we are supposed to imagine that an erstwhile despairing entrepreneur gets out of bed one morning and cries, “Hallelujah! The cost of coffee is up, cotton prices are surging, copper wire has just become exorbitant – I better go start a business before it’s too late!”

Well, yes, perhaps in those particular industries – assuming he has the aptitude, the means, and the ability to persuade someone to finance his eureka moment – but in any other line of business? Really?!?

Here we must force ourselves to pass over the objection that oil-driven inflation and lowered output are not necessarily such unfailingly automatic bed-fellows (see the late Boom) with only the brief observation that this confluence generally originates from either the second-order effects of a prolonged, frictional price disco-ordination, or from CB action to rein in a generalized price rise which only its own, previously over-accommodative policy could ever have allowed to occur in the first place (Hint: with an unchanged supply of money, more spent on one item implies less spent on another).

Instead, we return our focus to this Laputan piece of pseudo-scientific mumbo-jumbo for what it reveals about the muddle-headedness which informs both the ineffable Bernanke Fed and its far too numerous counterparts elsewhere.

In confounding cause with effect; in sacrificing the micro to the macro; in falling victim to any number of category errors and logical non sequiturs; in pursuing, with unthinking mathematical rigour, a set of utterly unreasonable premises to the point of an untenable – indeed, a highly damaging – conclusion, we have a prime example of everything that is wrong in mainstream economics and a glaring illumination of why the state interference which this typically seeks to  justify has proven so counter-productive to this – or, indeed, to any other recovery of the past 80 years.

Perniciously, Mssrs Bodenstein, Guerrieri, and Gust even argue that the increasing material scarcity of an oil ‘shock’ can be even more effective at dissolving the ‘zero-bound’ – and so – err – lessening the general material scarcity being suffered in the slump – if the price rise progresses at such a steady pace that people expect it to continue for some fairly protracted period and if the monetary authority now makes it unequivocally clear that it will not respond to this rise in its habitual manner.

In other words, this strongly insinuates that the Bernanke Fed actually welcomes the current surge in the prices of many of the staples of everyday life; that it actually exults in the drain being exerted on family budgets; that it revels in the squeeze on profit margins being suffered by already-struggling small businesses, because it imagines this will serve to lower the reckoning of the ethereal construct of a generalized, future real interest rate and that this alone will serve to shower riches upon all who are presently suffering, in compensation for their present woes.

Never mind that it is not the general, but the specific estimation that his own, uniquely-determined, residual entrepreneurial income (i.e., the one left to him after deducting the costs of, e.g., his now pricier commodity inputs, Mr Bernanke) will exceed his tangible, pecuniary interest costs (not his airy-fairy, abstract, modelled ones) which incentivises the business leader to act, but, even under Blackhawk Ben’s own, Neo-Keynesian framework, there is something of a paradox at work here.

This lies in the fact that, however implicit it may be in the obscurantism of the Beelzebub of Bloomsbury’s magnum opus, in an economy locked into partial idleness (and a rather more widespread wastefulness) by the vicissitudes of a market-hindering institutional and political setting, the lubricative effect of a monetary debasement only comes about when that inflation is unanticipated.

Put another way, it is only when people who have been withholding previously saleable supplies of goods and labour from a now inconducive marketplace are tricked into releasing them at unchanged nominal – but lower real – prices that a purposeful dose of inflation can hope to offer any palliative effect. Conversely, if they do recognise what is afoot; if they do not succumb to so-called ‘money illusion’, then they will simply seek to reprice their services to offset the change and so no discernible impact on output or employment will result.

Yet here we have Bernanke and his breathless battalions of banknote bundlers about to embark upon the perilously disruptive process of engaging in a gross manipulation of asset values, interest rate settings, and currency parities by telling people explicitly that prices will both rise and rise more rapidly and for longer, and all with the Fed’s unreserved blessing and encouragement!

Quite what they expect to be the efficacy of any such a forewarned inflation as they do manage to generate after all this telegraphing and nudge-nudge-wink-winking one can only wonder.

There is also something of a ‘conundrum’ looming in the bond market which, so far as we are aware, has yet to be addressed in public forum.

This lies in the fact that the Fed’s avowed purpose is serially to raise prices and therefore to lower real returns to fixed income. Ipso facto, this should tend to raise nominal bond yields (with mixed consequences for other asset prices), yet, as the Fed has said, as explicitly as it can, it is desirous of lowering nominal, as well as real, yields all along the maturity spectrum.

So now, the more ‘successful’ it is at raising the spectre of inflation, the more it will be the only buyer of choice for the instruments which suffer the most in such circumstances – viz., longer duration bonds. Thus, it risks locking itself into a monetization spiral much as it did through and beyond the period of WWII, with who knows what ultimate consequences.

A lesser evil is that, in order not to infringe upon its own rules of conduct regarding the detailed composition of its portfolio, it may also encourage a renewed fiscal laxity on the part of a chronically incontinent Executive as this latter graciously seeks to supply the requisite quantities of paper eligible for the Fed’s largesse.

Finally, in a world anxious to resist such a devaluation, it is not at all evident that any concurrent decline in the external value of the currency will counter the rise in domestic prices to a sufficient degree so that imports are not rendered even more competitive in consequence and hence come to exacerbate an already highly politically-charged trade deficit.

Whatever the exact nature of the pronouncement scheduled to emanate from the Mad Hatter’s Tea Party next week, the prospect is therefore the dispiriting one of its drafters delivering a further, recovery-hampering dislocation to financial markets, one whose ramifications cannot fail to spread across the whole of commerce and industry to the uttermost corner of the world.