The wages-fuel-demand fallacy

In recent months talking heads, disappointed with the lack of economic recovery, have turned their attention to wages. If only wages could grow, they say, there would be more demand for goods and services: without wage growth, economies will continue to stagnate. It amounts to a non-specific call to stimulate aggregate demand by continuing with or even accelerating the expansion of money supply. The thinking is the same as that behind Bernanke’s monetary distribution by helicopter. Unfortunately for these wishful-thinkers the disciplines of the markets cannot be bypassed. If you give everyone more money without a balancing increase in the supply of goods, there is no surer way of stimulating price inflation, collapsing a currency’s purchasing power and losing all control of interest rates.

The underlying error is to fail to understand that economising individuals make things in order to be able to buy things. That is the order of events, earn it first and spend it second. No amount of monetary shenanigans can change this basic fact. Instead, expanding the quantity of money will always end up devaluing the wealth and earning-power of ordinary people, the same people that are being encouraged to spend, and destroying genuine economic activity in the process.

This is the reason monetary stimulation never works, except for a short period if and when the public are fooled by the process. Businesses – owned and managed by ordinary people – are not fooled by it any more: they are buying in their equity instead of investing in new production because they know that investing in production doesn’t earn a return. This is the logical response by businesses to the destruction of their customers’ wealth through currency debasement.

Let me sum up currency debasement with an aphorism:

“You print some money to rob the wealth of ordinary people to give to the banks to lend to business to make their products for customers to buy with money devalued by printing.”

It is as ridiculous a circular proposition as perpetual motion, yet central banks never seem to question it. Monetary stimulus fails with every credit cycle when the destruction of wealth is exposed by rising prices. But in this credit cycle the deception was so obvious to the general public that it failed from the outset.

The last five years have seen all beliefs in the manageability of aggregate demand comprehensively demolished by experience. The unfortunate result of this failure is that central bankers now see no alternative to maintaining things as they are, because the financial system has become horribly over-geared and probably wouldn’t survive the rise in interest rates a genuine economic recovery entails anyway. Price inflation would almost certainly rise well above the 2% target forcing central banks to raise interest rates, throwing bonds and stocks into a severe bear market, and imperilling government finances. The financial system is simply too highly geared to survive a credit-driven recovery.

Japan, which has accelerated monetary debasement of the yen at an unprecedented rate, finds itself in this trap. If anything, the pace of its economic deterioration is increasing. The explanation is simple and confirms the obvious: monetary debasement impoverishes ordinary people. Far from boosting the economy it is rapidly driving us into a global slump.

The solution is not higher wages.


  • Steven Farrall says:

    This message has been made time and time again. It isn’t new. It’s not particularly clever. What it is is bleedin’ obvious (‘scuse language). So why don’t ‘they’ get it?

    Answer. Because turkeys don’t vote for Christmas.

  • Alasdair Macleod assumption that an increased money supply leaads to excess inflation is just a straw man argument. It’s blindingly obvious to mentally retarded ten year olds that if a GROSSLY EXCESSIVE amount of money is distributed, we get excess inflation. On the other hand if the private sector for some reason is not spending enough to bring full employment, and if if enough money is printed to induce a bit of excess spending, but not too much, that can lead to full employment WITHOUT excess inflation.

    • Andy V says:

      In the heyday of Keynesian economics, many economists believed that inflationary government policies could reduce unemployment, and early empirical data seemed to support that view.

      The inference was that the government could make careful trade-offs between inflation and unemployment, and thus “fine tune” the economy.

      Milton Friedman challenged this view with both facts and analysis. He showed that the relationship between inflation and unemployment held only in the short run, when the inflation was unexpected. But, after everyone got used to inflation, unemployment could be just as high with high inflation as it had been with low inflation.

      When both unemployment and inflation rose at the same time in the 1970s — “stagflation,” as it was called — the idea of the government “fine tuning” the economy faded away. There are still some die-hard Keynesians today who keep insisting that the government’s “stimulus” spending would have worked, if only it was bigger and lasted longer.

      This is one of those heads-I-win-and-tails-you-lose arguments. Even if the government spends itself into bankruptcy and the economy still does not recover, Keynesians can always say that it would have worked if only the government had spent more.

      • You don’t understand very much about economics if you think a government that issues its own money (e.g. US, UK, Japan, etc) can go “bankrupt”. Whatever debts such a government incurs nominated in its own currency, it can always print its way out of trouble. The result may be hyperinflation. But such a government cannot go bust.

        Re the 1970s inflation, that was cost push inflation: caused by stroppy unions in the UK. Witness the fact that labour took a record high proportion of GDP in the 70s. As a Keynsian, I certainly would not have advocated a bigger deficit in that scenario.

        As for the idea that government spending (or more accurately the deficit) is excessive at the moment in the US, Europe or the UK that’s just laughable. Inflation is low, and in the case of Europe, its at a record low.

        As for Milton Friedman’s idea about ACCELERATING inflation (i.e. NAIRU) I’ve always regarded that as a very boring trite little idea. He was probably correct, but there are some much more interesting ideas he pushed, e.g. the idea that no government should ever incur any debt: an idea I support. He also favored 100% reserve or “full reserve” banking, which I also support.

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