Imagine, if you will, a small, isolated hamlet where the daily round proceeds in harmony with the gentle rhythm of agriculture. Ground is tilled, seed is sown, crops are harvested, dried, threshed, and milled, each in their due season. In the lush, green meadows a little higher up the valley cows are impregnated before their calves are led docilely off to slaughter – both for their meat and for their cheese-making stomach enzymes. The kine turn the sweet grass which covers the pasture into much-needed fertilizer for the arable lands and, twice daily, milking takes place according to its own timeless routine.
Into this bucolic idyll now intrudes an ambitious village headman who has heard that he can further his own lot in life if he erects a series of shrines to the glory of the Emperor who is honourably busying himself with the mandate of heaven, far away in the stately pleasure dome of his Celestial Palace. Work begins at once, employing both those locals who have too little to do and, in due course, attracting itinerant labourers to the village.
Since the business of shrine building produces nothing tangible of itself – no new stands of millet or of teeming paddies of rice, no additions to the lowing herds of cattle – it is necessary that all those set to constructing them be given a share of the existing produce of the land. Thus, the biddable farmers are constrained to eat less heartily of the fruits of their own labours so that the community’s meritorious contribution to the cult of the Emperor may better be advanced. Not wishing to be seen as grasping, those toiling to break the rocks and pile up the cairns which constitute the sacred monuments are also persuaded that they, too, should forego the immediate enjoyment of the entirety of their daily wage and should also set some of it aside as their own offertory act.
So as to recognise the sacrifice each has made – a propitiation which each fully expects will earn him a future reward in something a little more material than the Emperor’s gratification alone, though from whence exactly none can truly say – the village scribe diligently records the size of each implicit donative against the name of its pious contributor in his scrolls (implicit since each has already been used up as surely as if they were burned in some great communal hecatomb). Slowly then and at no little personal cost in denial, if not outright privation, this local register of deeds grows longer, keeping as it does a tally on the mounting sum of savings being laid down by the dutiful and the diligent.
Imagine then, the consternation which ensues when, one fine spring morning, a courier rushes into the market square and, gathering his breath, proceeds to read out the latest proclamation from an imperial capital so far removed from their daily experience that few in the village have any firm conception of either its extent or its location. The Most Venerated Prince has decided, the messenger declares, that the count of the shrines being dedicated to the royal personage is become too large and that His Highness’ most farseeing haruspices and horoscopists have persuaded Him that it is unseemly for an earthbound divinity such as He to be seen to rival in this way the worship of the true Immortals in all their celestial splendour.
Henceforth, all such construction is to be halted and no more oblations are to be made in His most blessed name. No one, the herald continues, is to ‘save’ any further, upon pain of exciting both the Emperor’s awful displeasure and the thunderous anger of the Sky Gods whom He, too, serves in his turn. Instead, each must consume up to the very limit of his income and entertain no further thought of laying in a store against a future already so lavishly provisioned for.
But, goes up the cry, where will we, His Majesty’s most loyal temple builders, earn our bread, if the farmers do not continue to set aside our due portion? Are we, too, to follow the plough tomorrow? And, if so, who will grant us the lands, the tools, the skills to enable us to do so? All we have to hand are these well-used chisels and thrice-repaired picks. All we otherwise possess is a certain facility in the mason’s art. Surely these will not now serve to fill our empty bellies and still the crying of our hungry children?
And, for our part, how will we achieve any measure of recompense for the manifold portions already foregone, howl the farmers who have come to realise that their ‘savings’ are nothing but an empty twirl of the calligrapher’s brush, that they represent no bounty – present or prospective – to see them through their dotage or to pay their daughters’ dowries? Indeed, beyond a sterile list of claims to ownership of the many useless piles of now deconsecrated rubble, to what has all their devout abstinence amounted, they wonder. Will these bring forth butter or bread on which to spread it? Will it give us flax for our wives to spin into clothing, or hide to keep us shod, they quail?
“Be still, you wretches!” comes the haughty retort of the imperial mouthpiece. “His Most Elevated Puissance has become aware that the world is out of balance, that Yin does not match Yang, that there is too much investment in tomorrow and not enough indulgence here today. This must cease forthwith!”
“What is it to Him if you did not fashion mills to grind your corn or locks to render navigable your streams – and so increase the size and richness of your coming reward – but instead you sought to curry the royal favour by erecting rough-hewn altars to His cult on every rutted cart track and every dusty crossroads? The time has come, His most learned astrologers have ruled, to eat your way to wealth and for those who have hitherto laboured in what they misguidedly took to be His service to do the same for you farmers in your own homes. His mages, in their unfathomable wisdom, have determined that this way, and this way only must be followed: that the erstwhile builders will hew your wood and carry your water, they will sweep your paths and carry in the tapers to light your rooms at night. In short, they shall come to share your table openly with you and, in so doing, will ensure that it straightways will groan under the weight of all that greatly augmented whole that will instantly appear to be laid upon it.”
It was realized—if grudgingly—that this arrangement would not be entirely without merit: the farmers were used, after all, to feeding the temple builders and this way they would at least be free to devote more of their energies to higher order tasks and less to menial ones in return. Nevertheless, it came as a rude awakening to one and all to realise that where they thought they had been piling up the riches with which to ease their lives in future, all of their sacrifice had availed them naught and they would have to start again from their beginnings, poorer if hopefully wiser.
No word was said as to what the scribe should do with all those carefully guarded scrolls, now rendered utterly worthless by dint of the Imperial whim. The man himself was cautious enough quietly to make his exit, long before he could be blamed for what he had only wrought at the behest of his masters.
‘Feeling the Stones’, but Drowning Still
Ok, so, folksy analogies aside, we have to confess that not every ‘investment’ laid down in modern China is a folly; that not every plant operates far short of its capacity; that not all ‘profits’ are an artefact of hidden subsidies, false accounting, the shameless exploitation of captive savings, and a vast monetary influx, as in our little parable.
Nevertheless, in far too many instances this has indeed become the case. Moreover, the situation is far more fraught than was that which prevailed in our simple village economy because the scribe’s register of ‘savings’ there have as their actual counterpart the liabilities of the financial system. These, as we know, are not simple transactions recorded between two directly consenting counterparties, but are the nodes in a web of a myriad of subsequent interdealings whose complexity is beyond comprehension and whose strands comprise the means of circulation of goods and services everywhere they would go within the economy.
Thus, it is all well and good to declare by way of some sort of macroeconomic truism that we ‘need’ less investment and we ‘need’ more consumption and that the Kuznetsian Y will remain unchanged if C rises and I falls in a like manner and in the same timeframe, but that exquisitely interconnected, ever-evolving meta-organism which is an economy cannot be reduced to such a trivial game of adding more of one thing here and taking away some of another there as if we were simply hanging baubles on a Christmas tree.
For a start, the ability to consume must be in some way linked to the fact of having completed a prior act of production, whether we look at how one acquires an ‘effective’ demand upon such product or how one gains access to the requisite supply. Where that linkage is broken, as when credit creation or money printing tries to circumvent this necessary order of precedence, the consequences are always invidious and usually pernicious, to boot.
Secondly, each particular action, whether of consumption or production, is only sustainable – i.e., can be undertaken without unduly limiting the future possibilities for either its repetition or amendment – to the extent that it is integrated into the greater whole of all such actions, a condition which implies not just the instantaneous, but the intertemporal coherence of intentions.
Thirdly, each is dependent not only on the shifting sands of individual subjective preference, but its commission typically depends on the purposeful employment of both specific human skills and a dedicated, non-versatile endowment of capital.
Fourthly, much as the curvature of spacetime gives rise to the gravitational effects on a mass which then curves that same spacetime, each action cannot fail to effect changes in the milieu in which all subsequent actions must be planned and carried out. Thus, in this most Heraclitan of worlds, all is flux, meaning that not even the most bolted down, immovable hunk of plant or machinery should ever be confused with ‘capital’ per se (that would be to commit the same kind of error of association as is entrained in Marx/Ricardo’s labour theory of value and its ‘cost of production’ school among the resource analyst community).
Nor should it be considered to have any meaningful degree of ‘permanence’ simply because of its physical durability: function is what matters, not form and, moreover, it should never be forgotten that the true function of capital is to produce positive net income, not the things which we (mostly) trade onwards to others in order to assure receipt of that income. Indeed, we would do better to disembody our conception of capital entirely and to view it solely as a collection of property rights (including the primal right of self-ownership) from whose use we aspire to generate that net income over time and whose composition we must constantly adjust to fit the ever-changing circumstances in which it must be employed and which its very employment also alters.
Finally, in our intimately financialized economy, each one of our undertakings leaves its own trail of obligations given and received, each of which pathways of itself forms the foundation for yet other layerings of promise and contractual delivery. Thus, were our hamfisted attempts at puppeteering to cause a certain critical level of disruption to the operation of and – perhaps more importantly – the faith in one of these trackways, a cascade of failure could all too easily result turning as we Austrians like to say, an initiating monetary problem into a real one.
Thus, it borders on the facile to presume to re-arrange the pawns on the macroeconomic chessboard by lifting them off and putting them back, one by one and regardless of the actual progression of the game, but it is an exercise which not even the grandest of grandmasters could accomplish to orchestrate the march of the pieces from one such position to another not only while they are all moving at once but, indeed, doing so according to their individual expressions of will and, moreover, while they are simultaneously changing not only their own shapes and capabilities for movement, but redrawing the very dimensions of the board as they do.
China – or should we rather say, the individual Chinese – would undoubtedly be better off in an environment where more room was allowed for the ‘spontaneous order’ of consumer sovereignty under property rights to emerge and less was reserved for the corrupt gaming of central diktat, but to avow this is not to assume either that the transition will be seamless, much less painless, nor to accept that it can be so ordained simply by exchanging one set of fiats and public choice manoeuvrings for another.
But, never underestimate the penchant of the crude Keynesians for patent nostrums, state worship, and the elevation of hidden-cost collectivism to a guiding principle. Thus it is that, among the encomia for reform, we hear such idiocies as the following, oft-parroted, Cargo Cult wishfulness:-
[China should] Reform the Hukou system through creating a path for rural migrants to gain affordable housing and social services in urban areas. This could unlock much more consumer spending because, at the moment, some 270 million migrants who lack access to these services are forced to save hard to pay for their families’ education, healthcare and housing, etc…
-which is to imply nothing less than if the migrants themselves do not have to save, no-one else will either since the tutelary welfare state is, after, all a Tooth Fairy!
‘Cutting the Wrist’ with a Blunted Blade?
In the present vogue for voicing the previously inexpressible – presumably as part of the strategy to persuade the diehards that change is an unavoidable imperative – one of the New Men of the reform movement, Fang Xinghai, ex-Shanghai, World Bank, and Stanford, warned that many small banks were horribly over-reliant on wholesale sources of funding – to the tune of no less than 80% in some cases, Fang alleged – thus making them highly vulnerable to a run and of then acting as the ‘triggers’ in a possible asset price ‘cascade’.
To say such things openly is indeed to peer into Pandora’s Box. Total Chinese banking assets currently stand at some CNY147 trillion, around 2 ½ times GDP. As such, they have doubled in the past four years of increasingly misplaced investment and frantic real estate speculation, adding the equivalent of 140% of average GDP – or, in dollars, $12.5 trillion – to the books. For comparison, over the same period, US banks have added just less than $700 billion, 4.4% of average GDP, 18 times less than their Chinese counterparts – and this in a period when the predominant trend has been for the latter to do whatever it takes to keep commitments off their balance sheets and lurking in the ‘shadows’!
Indeed, the increase in Chinese bank assets during that breakneck quadrennium is equal to no less than seven-eighths of the total outstanding assets of all FDIC-insured institutions! It also compares to 30% of Eurozone bank assets (which are broadly unchanged over our chosen horizon, but which do represent an even more scary 320% of GDP and, in many cases dispose of worryingly scanty tangible equity ratios, q.v. below).
Published NPL ratios are reassuringly low and, as a result, earnings seem wonderfully robust, but it simply defies belief to accept either of these at face value, given that we know the Chinese leadership itself is terrified at the state of the nation’s finances.
It is for this reason, as much as any other, that we will believe all the brave talk about capital account liberalization and exchange rate reform when we see it. It would be simply too dangerous for a country stuffed to the gunnels with Ponzified finance raised against a plethora of underproductive assets and overpriced properties. If the PBOC wants to see its $3.7 trillion reserve stash evaporate amid a flirtation with becoming the 1997 Thailand of the current decade, we suggest it proceeds to abolish its controls at its earliest convenience.
It is too early to be justifiably pessimistic and too tempting to let scepticism shade into cynicism, but no-one can readily deny that the implementation of all these much-vaunted reforms will not take place without a struggle: too many losers will be created, who must either be compensated or else outweighed in influence by the new winners who emerge.
Take the relaxation of the one-child policy. We already harbour some doubts about just how much pent-up Maternal Instinct there exists in a nation of increasingly professionalized, materially better-off women (a group for whom the indisputable global precedent is that they voluntarily rein in their fertility) whose dream of owning a suitable home in which to raise the first, much less the second, child is ever less realizable thanks to China’s soaring property prices.
On top of this, it has already been admitted by the ruling National Heath and Family Planning Commission that the policy will be left largely to the discretion of lower levels of government to enact, that “there will not be a unified timetable” in recognition of the fact that “preparations or conditions might not be mature in some regions”.
We might suspect that Hukou reform will be seen to require a similar, locally-sensitive and hence inherently piecemeal enactment. Shame about all that ‘consumption’ we might have to forego among those looking forward to cracking open a bottle of Maotai the minute they receive their state pension booklet.
Then there is the ingrained habit which will be hardest of all to break: namely that the facilitation of shrine building – sorry, ‘investment’ – is the raison d’être of being a local government official. Take the report from this week’s, post-Plenum edition of First Financial News which pointed out that the joint spending plans of ten Chinese provinces amounted to a stupefying CNY40 trillion – or 80% of nationwide GDP! Clearly they did not get the latest memo from Chairman Xi.
Before leaving the topic of China, there is just one other faint concern to address; viz., the demotion of the previously ubiquitous champion of reform, Premier Li, almost to the status of Unperson as his superior, President Xi, conversely, has undergone a veritable apotheosis in recent weeks.
Though not quite airbrushed from the May Day balcony shot, Li has been obviously and humiliatingly relegated to the inside pages of late, having conducted such pressing duties as entertaining the Romanian PM on the sidelines of a conclave of central and eastern European leaders in the throbbing heart of Uzbekistan and of chairing a State Council meeting whose agenda read like the trailer for an edition of the BBC’s consumer affairs programme ‘Rogue Traders’ at which our man set his face firmly against the evils of counterfeiting and the future sale of ‘shoddy’ goods. (There goes the Chinese Mittelstand, we are tempted to observe).
Though much has been made of the significance of the newly-instituted Central Leading Committee for the Comprehensive Deepening of Reform (don’t you just revel in the wilder flights of Socialist Newspeak?) and of its possible role in stymieing the local cadre-friendly NRDC, there is a growing suspicion that Li himself will not be selected to head it. If such whispers have any merit to them, this would mean that Xi’s thirst for personal power has already come at the expense of the better co-ordination of the reform push. Watch this space.
Five years and more since the successive collapse of the pillars of the American financial system ushered in our present dire ‘unorthodoxy’, it should be obvious that overabundant money is no substitute for a lack of genuine capital. It should also be readily admitted that artificially low interest rates cannot be guaranteed to overcome the many disincentives to entrepreneurship which currently exist. How else could it be in a world where the profit motive is so universally condemned? How else when any businessman worth his salt knows that he is being asked to spend his energies and pledge his future well-being in pursuit of customers who either themselves are not financially sound or who suffer under a government whose own straitened condition may, at any moment, seek to rob them of whatever wealth they have so far managed to preserve.
In such an environment, where the ‘rentiers’ are again being slowly suffocated (in a process far too painful and protracted ever to be dubbed ‘euthanasia’), the effusions of the central banks are, all too predictably, giving rise to the most elevated of Cantillon effects in which those who have access to the cheap credit which their policy openly aims to make available can leverage it up into spectacular gains by speculating in the traditional vehicles of financial claims, real estate, and such fripperies as art and antiques. Thus, the financial wheeler-dealers flourish while the salarymen struggle onward, the retired rein in their aspirations, and the smaller business suffer in a world of uncleared markets, elevated costs, and state-subsidized and bank-evergreened zombie competitors.
Now it may be that Professor Krugman can insist that the grossly inequitable distributional effects which this brings about – letting the GINI out of the bottle as we have elsewhere categorised it – are somehow benign (his irrational hatred of the thrifty clearly overlapping with his bien pensant contempt for the rich with whom he presumably identifies them and thus overcoming his equally demagogic distaste for bankers). But we are far more sympathetic to the analysis presented by that eminently more reputable economist, Axel Leijonhufvud, who, in an address to Cordoba University in Argentina a few months back, dealt decisively with just this malign side-effect of the central banks’ ‘every tool is a hammer’ approach to policy, declaring that:-
Most of all, reliance on monetary policy has the inestimable advantage that its distributive consequences are so little understood by the public at large. But relying exclusively on monetary policy has some unpalatable consequences. It tends to recreate large rewards to the bankers that were instrumental in erecting the unstable structure that eventually crashed. It also runs some risks. It means after all doubling down on the policy that brought you into severe trouble to begin with.
Prof. Leijonhufvud, noting that the privileges extended to our limited liability money-creators are ‘in effect transfers from taxpayers as well as from the mostly aged savers who cannot find alternate safe placements for their funds in retirement’ and talked of the effortless enrichment to be had by those who can borrow at near zero rates from the central bank and leverage it up multiple times to buy higher-yielding government paper, all the while patting themselves on the back – and padding themselves in the pocket – for their genius.
Coincidentally, while writing this, we were sent a report condemning the large French banks’ lack of progress in restoring their finances to anything resembling a structure which could endure the slightest adverse gust were all these implicit and explicit state guarantees not so readily extended to them. Taking a quick look – more at random than out of any more studied approach to finding the worst offender – we checked the broad-brush financials for one of them, Credit Agricole, on the Bloomberg.
Mon vieux Agricole disposes of assets of around €1.8 trillion – not far short of a year’s worth of French GDP – against which it holds in reserve an official ‘Tier 1 Risk-Based Capital Ratio’ of 10% and a ‘Total Risk-Based Capital Ratio’ of what looks likely a highly conservative 15.4%. But therein lies the rub – namely, in the weasel words ‘Risk-Based’ and ‘Tier 1’. If we look at a good, old-fashioned measure like, say, tangible common equity to total assets, the cushion between continued existence and business failure falls to the exiguous level of 1.27%.
Putting that another way, for every euro of equity to hand, this one bank has piled €78.74 of assets – funding a hefty portion of them, no doubt with the BdF’s favourite little, officially-endorsed, ECB collateral-eligible, exceedingly short-dated titres de créances négociables. Our good Swedish professor would be in danger of choking on his smorgasbord if he were to read of such a crass degree of state-sponsored hyperextension.
We would also gently remind the reader here that, in Hayek’s sophisticated reading of the economic problems we create for ourselves, he relied heavily on a similar concept of distributional unevenness – rather than that of an indiscriminate aggregate demand shortfall – for an explanation of why the Gutenberg School of Economic Quackery should never be allowed the final word.
So, no, Prof. Krugman, savers cannot presume to be ‘guaranteed’ a positive real return on the sums they set aside (though you no doubt hope that those looking after your own, no doubt substantial nest egg will manage to achieve this very feat). But what they can rightly demand from a just society is that the only risks they run are everyday commercial ones and they are not systematically robbed by feckless politicians following the kind of crude leftist trumpery which you and your kind never cease to espouse.
No treatment of these issues would be complete without a brief nod to the spreading predilection for invoking an explanation for the inconvenient fact that we are not responding in textbook fashion to the potions, poultices, and bleedings being administered to us by our leeches at the central banks. This is the hackneyed old idea that we have somehow lapsed into a period of ‘secular stagnation’ – a wasting disease wherein our utter satiety with all the riches which a technologically mature society can shower upon us leaves us enfeebled and enervated, all compounded by the fact that our ineffable ennui has led us to procreate with ever decreasing regularity to the point it is threatening, horror of horrors, to make our blue sapphire of a planet a little less crowded than once we feared it might become.
Heaven forbid, but the latest sermoniser to propagate this nonsense was none other than Larry Summers – the man some thought might actually be a bit, well, less open-handed had anyone had the temerity to risk installing him as Blackhawk Ben Bernanke’s successor – suggesting that maybe Madame Yellen was not the worst choice, after all.
Dear old Larry has come over all Zero Bound constipated, fretting that the natural, real rate of interest has somehow become fixed down there at negative 2%-3% where conventional policy (if you can still remember of what that used to consist) cannot get at it – unless we blow serial bubbles, that is, these episodes in mass folly and gross wastefulness now being raised to the level of such perverse desiderata of which Krugman’s only partly-facetious call for a war on Mars forms an infamous example.
In fact, this entire notion is another piece of nonsense to spring from the one of Keynes’ least cogent ramblings, the notoriously insupportable notion of ’Liquidity Preference’ – a logical patch fixed over the lacunae in his reasoning when, having insisted that saving must always equal investment, all he could think of to determine the rate of interest was our collective desire to hold money for its own sake. From such intellectually bastard seed soon sprang, fully-armed like Minerva from the head of our economic Jove, the even worse confusion of the ‘Liquidity Trap.’
Not only Austrians, not only Robertsonians, not only Wicksellians like our man Axel Leijonhufvud have shown this to be a nonsense – easy enough since all of these generally look in some way at the balance being struck between the funds made available for loan according to potential savers’ subjective degree of time preference and the eagerness with which these funds are sought with regard to would-be entrepreneurs’ estimations of the profitability of their projects. But even Keynes himself all but confessed he had the whole thing backwards less than a year after that infernal tract, ‘The General Theory’, was first published.
Responding then to concerted criticism of his peculiar concept of interest rate determination as an internal mental conflict conducted in the heads of ‘framing’-prone, stick-in-the-mud, ‘college bursar’ bond-buyers who would, he felt, resolutely reject unusually low market rates on gilts in favour of accumulating cash hoards , he was forced to admit that the main part of that demand for money which he found to be the root of all macroeconomic evil was not at all related to people’s supposedly irrational desire to hoard it for its own sake, but rather was due to their wholly unobjectionable aim of ensuring a ready supply of funds prior to making planned outlays from them, something Keynes, with uncharacteristic humility, admitted in print that he ‘should not have previously overlooked’.
Since Summers himself made reference to a man dubbed the ‘American Keynes’ – that avid New Dealer Alvin Hansen – who raised this spectre, seventy years ago, let us also refer the reader to the complete dismissal of this strain of thought accomplished by George Terborgh in his contemporary 1945 work, ‘The Bogey of Economic Maturity’.
As Terborgh summarised in what he called a ‘thumbnail sketch’ of this theory:-
Formerly youthful, vigorous, and expansive… the American economy has become mature. The frontier is gone. Population growth is tapering off. Our technology, ever increasing in complexity, gives less and less room for revolutionary inventions comparable in impact to the railroad, electric power, or the automobile
Robert Gordon and Tyler Cowen are hardly the trailblazers they like to imagine they are, either, it appears -
The weakening of these dynamic factors leaves the economy with a dearth of opportunity for private investment… Meanwhile… savings accumulate inexorably… and pile up as idle funds for which there is not outlet in physical capital, their accumulation setting in motion a downward spiral of income and production… the mature economy thus precipitates chronic over-saving and ushers in an era of secular stagnation and recurring crises from which there is no escape except through the intervention of government.
In short, the private economy has become a cripple and can survive only by reliance on the crutches of government support.
Two hundred-odd closely-argued and empirically-rich pages later, Terborgh sums up as follows:-
If… we suffer from a chronic insufficiency of consumption and investment combined, it will not be… because investment opportunity in a physical and technological sense is persistently inadequate to absorb our unconsumed income; but rather because of political and economic policies that discourage investment justified, under more favourable policies, by these physical factors.
As Wikipedia laconically notes in its biographical sketch of Terborgh’s protagonist, Hansen, the verdict of history was unrelenting:-
The thesis was highly controversial, as critics… attacked Hansen as a pessimist and defeatist. Hansen replied that secular stagnation was just another name for Keynes’s underemployment equilibrium. However, the sustained economic growth beginning in 1940 undercut Hansen’s predictions and his stagnation model was forgotten.
So, why should we not forget it, too? Only because, as Terborgh was only too aware, the popularity of such views is a gilt-edged invitation for continued, large-scale interventionism by the Bernankes, Summers, and Yellens of this world and there will surely come a point where the slow drip, drip of these will utterly undercut the foundation of our modern order and usher in to office a much darker series of opportunistic overlords and aspiring saviours.
On that somewhat sombre note, we will leave matters for now, with only a pair of questions to ask of our present leaders by way of an epilogue:-
If, as you and your ilk mostly do, you affect to fear that we are somehow exhausting the planet’s capacity to give our species a domicile, how can you also be worried that we may be slowing down, dying out, and using less and hence presumably be making less of a call upon Holy Mother Gaia—and doing so, moreover, in a wholly voluntary fashion?
Furthermore, if you really do believe that we are on the verge of such a ‘stagnation’ as you describe—with all it implies for the potential dwindling of income streams and the drying up of future returns on capital—how can you reconcile the current, extraordinary buoyancy in the stock market with your firm insistence that no part of the policies you have been implementing can in any way have contributed to what must therefore be an untoward degree of optimism (aka a ‘bubble’) in the valuation of its components?
Answers, please, on a postcard.
The FT blog entry dealing with the Pope’s recent apostolic exhortation is, as we might expect, a somewhat tendentious selection, archly culled from the proclamation. But, in the spirit in which it is there presented, let us deal with a few of the passages excerpted.
While the earnings of a minority are growing exponentially, so too is the gap separating the majority from the prosperity enjoyed by those happy few. This imbalance is the result of ideologies which defend the absolute autonomy of the marketplace and financial speculation…
No, such gross inequalities arise only due to state intervention (not least in the imposition of flawed systems of state money), from state-granted legal privilege, and through the state-exercised, post hoc largesse which is routinely showered upon its favoured lackeys whenever they make one of their frequent gross errors of judgement or succumb to their all too typical and wholly execrable violations of ethics.
Let us here be clear, whatever the pope may think, tax minimisation is not one of the latter. A man’s honestly come-by income is his, not his petty overlord’s, to dispose of and all non-violent efforts he makes to reduce the depredations being visited upon that income are just. The problem with this contention is that the ability to do so not extend equally to all. Thus, the larger fish – flaunting their state-granted immunities – swim free while the smaller fry – who might one day grow to be their competitors were they not so viciously oppressed – are caught in the net and squeezed all the more mercilessly in order to make up a budgetary shortfall (which itself only seems so pressing because of the insatiable lust for power of their rulers).
Jesus may have made a point of cultivating the company of publicans – i.e., of tax farmers – as a way of showing up the self-righteousness of the Pharisees, but He was surely not suggesting that it was their office that was the highest of all callings in that it assisted the voracious state in its attempt at ensuring ‘a better distribution of income’ – better distributed to its functionaries and supporters for the most part, that is.
…they reject the right of states, charged with vigilance for the common good, to exercise any form of control. A new tyranny is thus born, invisible and often virtual, which unilaterally and relentlessly imposes its own laws and rules
Does anyone in their right mind really think the market makes the rules? If so, then why are we plagued with a cradle-to-grave, self-perpetuating, largely self-selecting claque of political parasites and bureaucratic busybodies whose path up the greasy pole to view ‘all the kingdoms of the world, and the glory of them’ consists of a never-ending striving to think up new rules, regulations, prescriptions and prohibitions to impose upon the rest of us, the better to prove the political ‘vision’ – and hence fitness for high office – of their promulgators?
Furthermore, it strikes one as the bitterest of ironies that in this flight of rhetoric the Holy Father has seemingly chosen to confound the utterly notional ‘tyranny’ of fair dealing and contractual fulfilment with the innumerable, very real horrors inflicted upon his flock by that most bestial of institutions, the state, throughout its long, bloody history.
In a true free market – however much of an abstraction that concept may, alas, remain – self enrichment can only come about as the reward for a meritorious success in best satisfying the material needs of others. This is hardly a ‘tyranny’. Indeed, if anyone is subject to such a binding constraint, it is the profit-seeking entrepreneur since, in such a world, he is a man who earns his daily bread by making sure others receive theirs at the lowest cost, in the highest abundance, on the most regular basis, according to the shortest delay, and comprised of the greatest quality. If he does not do so as a matter of basic business principle, he risks soon going hungry himself.
Moreover, the ‘worship of the ancient golden calf’ which is held up as so abhorrent a practice has always been something most pitilessly enforced by the state, not the market. Leviathan – in order to shore up the pillars of its earthly dominion – has typically either perverted true faith into a religion of diabolical service to own glorification, or else has set itself up as the secular deity, one to be defied only at the price of life, liberty, and property. It is therefore not the ‘idolatry of money’ wherein we meet the most awful, crushing, ‘inhuman dictatorships’, but in societies which pretend to despise honest trade and which prey upon fruitful commerce.
We can no longer trust in the unseen forces and the invisible hand of the market… [and when, pray tell us, did we ever get a chance fully to do that?]
Growth in justice requires more than economic growth, while presupposing such growth: it requires decisions, programmes, mechanisms and processes… [etc., etc.]
Perhaps we might encourage His Holiness to find time among his regular schedule of devotions to read a little Hayek and perhaps some Buchanan, for here he has succumbed to the fallacy of the pretence of knowledge and he is also gathering up tares, not wheat, by failing to take note of the teachings of ‘public choice’ theory. Planning – for that is what this passage is advocating - is the scourge which drove us into this mess in the first place. The very ‘decisions, programmes, mechanisms and processes’ being implemented by the idiot savants and the hubristic meddlers who populate the ranks of the influential are what keep us mired within that mess and so prolong the suffering of one and all, far beyond their due measure and far in advance of their allotted span.
Our new Pope is doubtless a man of unimpeachable piety and great personal humility, but what the chosen paragraphs appear to demonstrate is that the concept of his infallibility is rightly reserved for his considered pronouncements on matters of doctrine, not economics or even politics. Otherwise, instead of echoing the sentiments of such a leading light of humanitarianism as Che Guevara – whose Stalinist ramblings also dwelt on the ‘alienation’ suffered by the masses and who likened the market economy uncomprehendingly as a ‘contest among wolves’ – he would surely acknowledge that, for all the inevitable human failings of the individuals who make up the class, entrepreneurs routinely do, have always done, and always will do more good for more people in more instances than ever have or ever will the commissars, crony plutocrats, and corrupted vote-mongers from whom the Alphaville redactor (if not necessarily the Pope himself) finds them drearily indistinguishable or else beside whom she deems them decidedly less commendable.
The FT post itself concluded with fashionably cheap jibe en passant at the Tea Party – which it no doubt sees as a howling mob of ape-knuckled reactionaries stubbornly resisting all that uplifting soixante-huitard progressiveness which some of its authors and the rest of the more enlightened so joyously embrace. This itself reveals much about the ideological intent behind the careful culling of the Pope’s words, as does the breathless worship of Keynes and Krugman which has become FT Alphaville’s default setting.
Yet there are one or two phrases in the Apostolic which could be cited to support a completely opposite view of the world, as for example, when the Pope says:
…Today’s economic mechanisms promote inordinate consumption, yet it is evident that unbridled consumerism combined with inequality proves doubly damaging to the social fabric…
Agreed. But on the FT blog the talk is usually a wearisome rehearsal of ‘paradoxes of thrift’, ‘liquidity traps’, and of the need for programmes of economic ‘stimulus’ which are all aimed at fostering that two-masses-for-the dead, pyramid-building Uber-consumption of the kind which can only spawn what are ultimately unsustainable levels of ‘…Debt and the accumulation of interest [which] also make it difficult for countries to realize the potential of their own economies and keep citizens from enjoying their real purchasing power…’ – that latter a cry not to resort to any further inflationism, perhaps; not to mention a suggestion that we might do well to reduce, not inexorably increase, indebtedness, pace the Bloomsbury Sage and his brutish New York Times enforcer?
And as for the inherent collectivism of much of the commentary here, well, there is always this to consider:
…all this becomes even more exasperating for the marginalized in the light of the widespread and deeply rooted corruption found in many countries – in their governments, businesses and institutions – whatever the political ideology of their leaders.
Here, Pope Francis – if with perhaps not the greatest degree of consistency, given what he has argued earlier in his address – is categorically expressing his deep disapproval of those same enlightened, disinterested, Platonic philosopher-kings to whose tender judgement we are often told in the FT we should commit our care, lest the evils of the market come upon us as a wolf upon the fold.
Adding to this, in a different section, the pontiff argues that,
…the principal author, the historic subject of this process [of building a fair society], is the people as a whole and their culture, and not a single class, minority, group or elite. We do not need plans drawn up by a few for the few, or an enlightened or outspoken minority which claims to speak for everyone. It is about agreeing to live together, a social and cultural pact…
Not much room there for that sordid Republic of Men, not Laws for which we are enjoined to abandon that fructifying “social and cultural pact” which is the market.
Francis goes on:
…it is the responsibility of the State to safeguard and promote the common good of society. Based on the principles of subsidiarity and solidarity, and fully committed to political dialogue and consensus building, it plays a fundamental role, one which cannot be delegated, in working for the integral development of all. This role, at present, calls for profound social humility…
Here, ultimately, is the root of all our woes. Not the “absolute autonomy of the marketplace and financial speculation”, but the fact that none of those who hold sway over us – neither the unelected technocrats like Mario Draghi and Janet Yellen, the heads of our increasingly arbitrary governments – whether elective, theocratic, single-party socialistic, or monarchic in flavour – the sinister spymasters they have empowered to snoop and pry and curtain-twitch at our every thought and deed, nor the pettifogging officials they have let loose to harry us about our daily round – not one of them display much in the way of ‘social humility’, profound or otherwise.
Perhaps that’s because most of these worthies have never had to operate within the one institution most likely to inculcate such a virtue; the one in which the consumer – and not the producer – is sovereign; the one where the customer – not the merchant – is always right.
I refer, of course, to the free, unhampered market – the bringer of bounty and promoter of peace, the forum of fraternity and congress of co-operation where man meets with man in order to trade, mine for yours, to the mutual benefit of both.
No purple prose this time, I promise – I wouldn’t dream of risking any untoward interruption of your natural digestive processes – but I just came across the little invective (is there any other genre to which you turn your hand?) - in which you gave full vent to your scorn for my alleged lack of understanding of the banking system.
[Oh, and thanks for the editorial obiter dicta, but ‘fulfil’ is correct in real English, while the OED validates my use of both ‘nominated’ and ‘incongruous’. Typos are, alas, another matter for which you will just have to excuse one’s eternal inability properly to proof read one’s own work. It was however very stylistically astute of you, I must say, to exploit the frequent use of the [sic] insertion to make the subliminal suggestion that someone who apparently could not set grammatically accurate sentences on a page was ipso facto to be considered suspect in the coherent thought department, too! But, let’s not be too schoolgirlish about it. Onward to the point in hand.]
To chew over the first bone of contention and as you will not take my word for it that banks do create deposits by lending money, let me quote you a little Roepke from a footnote (p113) to his 1936 work, ‘Crises & Cycles’:
The process [of credit creation] is now clearly explained in any text-book on economics, banking or money (especially recommendable is Hartley Withers’ Meaning of Money). A fuller treatment may be found in the following books: R. G. Hawtrey, op. cit.; J. M. Keynes, A Treatise on Money, pp. 23-49 : C. A. Philips, Bank Credit, New York, 1920; W. F. Crick, “The Genesis of Bank Deposits,” Economica, June 1927, and F. A. von Hayek, Monetary Theory and the Trade Cycle, London,1933.
Without an understanding of this process and of its limitations, no real insight into the working of our banking system and, consequently, of our entire economic system seems possible, to say nothing of the mechanism of business cycles. There may still be many people who can no more believe the story of the genesis of bank money than they can believe the genesis of the Bible, but on the whole it now seems to be generally accepted. A last but hopeless attempt at disproving it has recently been made by M. Bouniatian, Credit et conjoncture, Paris, 1933. [Emphasis mine and apparently NOT the last!]
Or as Hayek indeed noted in ‘Prices and Production’ above his own lengthy footnote (pp 81-2):-
The main reason for the existing confusion with regard to the creation of deposits is to be found in the lack of any distinction between the possibilities open to a single bank and those open to the banking system as a whole.
Shall we hear from Mises? ‘Monetary Stabilization and Cyclical Policy’ (p105) seems pretty unequivocal on the matter:-
If the banks grant circulation credit by discounting a three month bill of exchange, they exchange a future good—a claim payable in three months—for a present good that they produce out of nothing. It is not correct, therefore, to maintain that it is immaterial whether the bill of exchange is discounted by a bank of issue or whether it remains in circulation, passing from hand to hand. Whoever takes the bill of exchange in trade can do so only if he has the resources. But the bank of issue discounts by creating the necessary funds and putting them into circulation. [which, incidentally, is an almost exact paraphrase of the argument I advanced and to which you took such exception, George]
Finally, let us allow Dennis Robertson a few words on the matter from the posthumous collection ‘Essays in Money and Interest’, p25:-
…bank money comes into existence mainly as the result of loans and investments made in the banking system… … Historically, there seems to me no question that the bulk of bank money in existence has come into existence in this way… If anyone retains any lingering doubts on this matter, whether these doubts arise from consideration of the multiplicity of banks or from some less rational cause, I commend to him the patient and careful article of Mr. Crick [see above]… Here time forces me to treat this particular controversy as closed. [Emphasis mine again]
Your basic case is that when a miller supplies flour to a baker on credit and takes the evidence of his claim on the latter to a bank to be monetized, the blameless Free Fractional Bank can only accommodate this demand once its managers are satisfied they already have sufficient, saved monies – either to hand or readily available – to honour whatever surplus of cheques it is which, as a consequence, will be presented to them at the next clearing.
This is utterly wrong, but to demonstrate my point, you will have to grant me a little empirical diversion.
Bundesbank data for aggregated balance sheets across the EZ show that, as of the end of QII, banking institutions (or ‘MFI’s) had taken in roughly 60¢ of deposits from other banks for every €1 owed to non-banks, and had extended a similar proportion of 60/100 in credit to other banks versus that granted to non-banks by means of loans or security purchases. In the first case, the total was some €7,617 billion outstanding, in the latter €9,515 billion – whether in absolute terms or at 38% of the relevant totals, hardly trifling sums.
Meanwhile, BIS data for cross-border banking shows an even greater predominance of ‘pig-on-pork’ with $19,204 billion in assets out of a total of $32,655 billion (59%) being claims against other banks and $20,875 billion out of $31,646 billion (66%) being liabilities due to other banks.
Clearing, did I hear you say? Clearing? Or, are we rather dealing with ‘money-from-thin-air’ pyramiding?
Since you so like to affect a folksy tone in your dismantling of opposing views, let me respectfully offer you a simple analogy in my turn.
Mick the Miller delivers flour to Bert the Baker in exchange for a post-dated IOU to the redeemable value of, say, $100. So far, so good – savers and lenders matched and nary a sign of inflation. Mick, however, next sells the note to Bartholomew the First Banker for a small discount and spends the $99.50 credited to his account on wages for the mill-hands. Matt the Miller’s assistant gets his paid into his account with Benjamin the Second Banker.
Alack and alas for your Trumpton theory of free banking, Ben does not send a runner, post haste off to present the cheque for clearing and thereby instantly expose Bart’s reckless issue of an unreserved demand claim, instead he goes searching for a convenient place to acquire an offsetting asset to put against his newly-assumed liability and typically ends up lending an equal amount to Bart in an interbank market which I have already demonstrated is still vast in extent, even today in our post-Lehman state of funk and even though I will grant you that as much as €1 trillion of this had to be further intermediated via the ESCB’s own balance sheets, using the TARGET2 system, at the height of the panic.
In this way (feel free to draw out the T-accounts if it is somehow not clear), money – i.e., Matt’s all too readily spendable credit balance in his demand account with Bank of Ben – has indeed been created ex nihilo. What is more, this has taken place long before Bert the Baker has had time to bring a fresh batch of his widely-praised Rustic Cobs out of the oven to sell to Matt and thereby begin the process of redeeming his own liabilities with an exchange of goods for the newly-created money. That creation was therefore inflationary, despite the complete absence of a central bank to muddy the waters in our toy community.
Not that this has exhausted the possibilities either. Banker Bart could simply sell Baker Bert’s IOU to Banker Ben, though obviously Ben will have to repeat the exercise if the recipient of Matt’s imminent expenditure does not himself bank with Ben. More likely Bart will try to repo it (effectively, pledge the IOU as security for the sum he needs to borrow from Ben). After all, this is a market which just in the US amounts to a $2.8 trillion daily turnover, a mind-boggling sum to which we can add the €11.9 trillion a month passing across the LCH in London and the €700 billion a day going via Euroclear. Furthermore, given the controversy which has arisen over the multiple use of such collateral as Bert’s IOU – its ‘rehypothecation’ in the proper jargon – we can be fairly sure that this innocent little promise to pay will be positively flying around the system, assuring the ready creation of ‘money-from-thin-air’ for so long as it remains in some banker’s or broker-dealer’s hands.
You might like to know that, many years ago now, I started out working in the Treasury department of a small international bank in the City and that several of my peers from that day now occupy decidedly senior positions in that same milieu. I can assure you that none of us had ever given much thought to the business of covering (or at least of matching) our loans before granting them up, right up until the late outbreak of unpleasantness. The working assumption was that funds could always be had in the short-date interbank market, even if a degree of interest rate risk was therefore unavoidable (indeed, this latter, offering the chance of a profitable arbitrage, was often the primary motivation behind the lending decision itself). Things may not be quite so free and easy post-2008, but the point nonetheless stands.
Incidentally, even with the baleful presence of the CB, you should be aware that for much of the last boom, as the result of a captured-regulatory race to the bottom, reserve requirements – and hence active, statist reserve provision – were so nugatory (indeed, in the UK they were both voluntary and the degree of that voluntarism was actually capped) that they were irrelevant to the everyday functioning of the banks in much of the developed world. Moral hazards and implied backstops were of course all too operative, but reserve provision per se was not really a determining factor in the contemporary insanity.
For reasons which escape me, it is widely recognised in your circles that the supposed automaticity of the restraint imposed by the classical gold standard was honoured more in the breach than the observance because of the ready resort to the creation of deferred claims between surplus and deficit entities (whether private or public) in place of any actual final settlement through the transfer of metallic reserves (you cannot afford to be too respectful of the role of the barbaric relic, lest you sound too Rothbardian, I suppose) and yet you seem to insist that the paper trail from every last, utterly mundane banking transaction must be instantly be presented for an equivalent, expansion-restricting act of ‘clearing’. To the contrary, you will find that whether conducted electronically or not, ‘note wars’ are a curiosity of the past and, it is my contention, would be likely to remain so even if the evil central banking were miraculously to be abolished.
It may be a truism of accounting that every asset has to have a corresponding liability (and that for entities such as banks, unlike for individuals and states, these must match internally, to boot), but this is to elide over the yawning gap between a genuinely ‘saved’ deposit and one which merely happens to have been caught on camera in someone’s possession at the instant of book-closing as it flits busily about between owners, performing its primary role as a medium of exchange.
Nor are we here even beginning to deal with the distortive effects of ex ante, desired versus ex post, forced savings (I think I am right to venture that I have not seen your school deal much with this concept either).
No. I would suggest to you that the dangers and distortions are much more immediate than that.
If Mick the Miller is turned into Mick the Mortgage Dealer and Bert the Baker into Bert the Bungalow-Buyer, I can hardly see it as a comfort that, when the accounts are squared up at COB each evening, there must necessarily exist a positive entry somewhere in the system (barring the more remote possibility of there existing a corresponding cash holding) or that this is very likely to consist of an inside-money, demand account one which, however fleetingly held between the act of buying and selling, has been transmuted via an equally transient interbank loan into the associated 30-year obligation.
Kind regards, from a ‘self-styled’ Austrian,
In Europe, the picture on one side of the banking balance sheet remains one of shrinking credit (more especially of the productive, private sector kind which is off 5.1% yoy after three years of relative stasis), and, on the other, of growing money supply, shrinking interbank reliance, and haemorrhaging non-EZ exposure (that first of these having seen its intrazone component reduced by an eighth since mid-2012, the second having fallen by 7%).
Though outright monetary shrinkage is now a thing of the past almost across the Zone, there has been no interruption to the tendency for people to hold assets in their most liquid form, nor for the banks to fail to find anyone other than Leviathan to whom to lend the proceeds – by way of bonds, for example, this last kind of accommodation is up 12.1% yoy, representing an increment of €200 billion which is almost equal-and-opposite to the coincident €240 bln decline in non-financial corporation loans. Crowding out, anyone?
Though everyone wishes to trumpet the claim that a smattering of PMI numbers which have at last clawed back to the 50 expansion-contraction watershed has somehow marked a turning point for the blighted region, this pattern of money and credit flows should show just how premature all this fanfare is.
Take another instance: Spanish banks’ loans to non-financial corporates have fallen 20% in the past twelve months to stand a third lower than their peak and to subside back to 2006 levels. Notwithstanding the 25% overall decline in retail sales in the past five years or so – a shrinkage which still shows no signs of abating – the stock of loans to households is only now beginning to dwindle with much of the 7.7% drop in outstanding mortgages coming in only the last year.
Meanwhile, of course, state debt mounts relentlessly skyward, swelling 18.9%, or almost €150 billion, in the twelve months to April and ballooning as a proportion of either overall income or of the government’s ability to raise revenue. Spanish banks, meanwhile, saw a 10% increase in their exposure to EZ sovereigns which remains at a level equivalent to 100% of their capital and reserves. Does anyone seriously think that more-of-the-same – which is all we are being offered – is the recipe to fix a witches’ brew such as this?
The UK, by contrast, may be suffering the effects of too successful an application of crank medicine – meaning poor old Mark Carnage may not get the opportunity to live up to his overblown billing as the home country’s monetary Messiah.
The supply of that money is growing rapidly (resident AMS is running at the sort of 10% nominal, 7% rate typical of the last expansion phase) while the unprecedented, circa £500 billion, 30% gap between M4 liabilities and M4 lending which opened up (and which was plugged by a perilous reliance on wholesale – often overseas – sources of funds) under those joint and successive Lords of Misrule, RobespiBlaire and Culpability Brown, has had 90% of that dreadful expansion unwound with the ratio between the two measures having fallen back to a 25-year low of around 8%. Such a newfound consonance between ends and means implies that the banks themselves will form no future hindrance to credit expansion, as and when the call next arises.
Thus far, though, private sector borrowing – whether individual or business – has been slow to respond outside the exploding student loan sector and the BoE’s figures on property loans and transaction counts seem moribund, despite anecdotal evidence of a resurgence which is reflected in the HBOS price aggregate but not, confusingly, in the Nationwide one. As we have recently argued, however, people do not necessarily need to borrow more in the aggregate to get things churning; they only need to downgrade their individual propensity to hold money as a store of value or as a precautionary ‘call option’ and to begin to employ it more avidly as a transactional medium for turnover to increase, velocity to rise, and asset prices to soar.
There have been any number of false starts in the UK, but it may just be that we are on the verge of entering into the zero to pi-by-two section of the rollercoaster once again. One paradoxical thing that is likely to result from such a change is that the dreadful state of the UK current account is like to become even more dire and yet, perversely, sterling may well strengthen if any uptick – however ephemeral – is seen by a market still broadly underweight the archipelago as diminishing the chances of any further QE by offering an island of growth (hothoused or not) in a cold, boreal ocean of contraction.
Stateside, we have navigated the four main eco-events of the week: the FOMC, the GDP revisions, the NAPM release, and the payroll report with a clear if slightly nervy bias to buying yet more stocks, front-running the dreaded ‘taper’ by selling bonds, and an intriguing hint of a switch from precious to base metals.
As for the Fed, the semantic second-derivative in its press statement was that the pace of recovery was categorized as ‘modest’ rather than ‘moderate’, which might be construed as a subtle hint not to expect policy to change in the immediate future.
The GDP numbers, undergoing their quinquennial revision, shifted a whole series of line items from the intermediate to the final category and hence grew the US by a Belgium or so overnight while moving a number of that measure’s historical wiggles ‘modestly’ up and a few others ‘modestly’ down, in an exercise which surely only serves to underline that our oft-expressed distaste for this jumbled aggregate is very well placed indeed.
We have long argued instead for a total economic spending/production gauge insofar as a one-figure characterisation of such a complex entity has any justification at all (who really believes there can be such a thing as a meaningful ‘global’ temperature anomaly, for example). Looked at that way—and apart from the fiddling which took place within the mystical realm of imputation (something we also try to strip out, due to our curmudgeonly prejudice for actual, cash-based transactions over the cloud cuckoo land of transfers of virtual goods and services) – not an awful lot would have been changed by this grand numerical vanity, as far as we can see at present.
In passing, are we to assume that the tiresome canaille of NGDP targeters are frantically redrawing their trend lines as we speak, before rushing out unblushingly to beg for even more inflationary impetus from the central banks, no matter what the result of this recast series? Probably, for it would be too much to expect that it afforded them a moment’s pause in which to reconsider the shaky intellectual and dangerous political basis for their fixation.
Sticking to revenue generation – no matter whether it takes place between businesses high up the food chain, or originates when Jane Doe fills her shopping basket – we think we get a better feel for what is happening (and how quickly it is doing so) all along the structure of production and since this approach gives an equal weight to such non-trivial, often more volatile sectors such as those two thirds of manufacturing which do not make it into the GDP count, or the similar proportion of wholesale and retail trade which does not even qualify for inclusion in the gross output numbers, the likelihood is that we get a superior read and certainly a more advanced warning of that potential trouble which is a constant goal of economic monitoring.
We leave it to those who care to give a detailed exposition of the minutiae of the changes effected: we would just like to wonder at the statistical arrogance which can recast numbers as far back as the Jazz Age. Regarding the ‘capital’ content of the ‘creative arts’, we are a little at a loss as to what smoothed, exponential, X-12 Arima adjustment one applies to a Picasso or a Monet in order to make it compatible with the ‘investment’ quotient of some modern installation artist’s cynical daubings of his excrement on a gallery wall. How did the Jazz Singer compare with Top Hat, or The Maltese Falcon with Goldfinger, the triumphant Dark Knight with the execrably dire Lone Ranger, or Madagascar XXVII against Fast & Furious XIX (or whatever instalment it is we are up to now)?
Then there was the pensions wheeze. Ironically being delivered in the week when S&P noted that the 500 index’s members posted record pension and post-retirement benefit deficits last year of no less than $687 billion, the BEA’s new methodology henceforth counts contribution shortfalls of this type as a notional loan by the firm on which it will pay virtual interest, thus adding a corresponding phantom amount to the totals for the personal income and personal saving of their employees! Taken to an extreme, if admittedly an absurd one, this would imply that were my boss to fail to adhere to any of the pecuniary terms of my contract, it should be a matter of indifference to me, since I will simply be lending him my salary alongside my pension, making me just as well-off as before, if a trifle less weighed down with coin until that happy day when (if) he munificently makes good the shortfall. Ugh!
Another reminder of the suspect nature of statistical series to whose fractions of a percentage change we insist on attaching a wholly spurious importance can be seen in the discrepancy between the BEA’s NIPA estimate of wages and those we can derive from the BLS employment figures. According to the first reckoning, private wage income rose a creditable 4.3% annualised from QII’12 to QII’13, but the latter’s hours x wages product only advanced 2.8% between the same two endpoints. Within that, the BEA figured that manufacturing wages increased by 2.7%, while the latter showed a less disparate, but still noticeable, 2.4% increase.
As for the employment report itself – another of our less esteemed statistical pots pourris – this was, on the face of it, mildly disappointing, with an unremarkable 165k jobs added in July and back revisions subtracting a further 26k from the running total.
In fact things were worse still, if we suspend our usual cavils and take the numbers we were given at face value. Consider that, of the one million new jobs added in the last four months, less than a fifth were full-time in nature (thank you, Obamacare!) while no less than seven-eighths were taken by women. Nothing against the ladies, per se, you understand, but it is an undeniable fact – over whose possible cultural, institutional, and biological causes we have no wish to become embroiled – that the average female job involves less pay, fewer hours, and a deal less value added than the average male job.
Hence, while any expansion of work is not to be sneezed at, nor any honest labour derided, it is nonetheless hard to escape the conclusion that things are not exactly cooking with gas. Partial corroboration here can be had from a glance at the BEA’s guess at real, per capita disposable income which has grown in the past year by precisely zero percent, even if you accept their lowball 1.1% deflator and the higher salary count we discussed above as acceptable inputs to the calculation.
Attacking this from another angle, we can also see that there has been no new increment of manufacturing hours since the start of last year while the real wage fund (hours x pay / CPI) is falling at close to a 1% annual pace – not yet slow enough to signal a full-blown recession (under the mainstream classification, at least) but a matter of no little concern, regardless.
Add to this the fact that manufacturing shipments have dipped to a level which has been followed by a recession every time it has occurred in the past quarter-century bar one if you allow us to promote the Asian Contagion of 1998 (which brought severe hardship to half the people on the planet and panicked the West into effecting some rather damaging rate cuts) to honorary membership of the NBER’s US Recession Hall of Infamy – that sole exception being the occasion of the 1996 GM autoworkers’ strike whose settlement saw a swift restoration of normal service.
Widening out manufacturing to add in trade sales and a similar picture emerges: business is as slow as it has ever been outside of a recession over a forty-two year stretch – this time barring only the ‘false alarm’ in 1986-7 which was, at the time, nonetheless sufficient to spook the incoming Greenspan Fed into slashing interest rates by 2 1/8% in short order and so to leave the funds rate at ten year lows.
Given all this, the last big number of the week above was truly extraordinary, for the NAPM jumped from a lacklustre 50.0 all the way to a two-year high of 55.4. Along the way, the production component soared to a nine-year peak which was in the 95th percentile of the last half-century’s readings after a two-month gain so exaggerated that it hit the 3.3 sigma mark and so intruded into territory previously reserved for the initial snaps-back from the deep recessions of 1974-5, 1981-2, 1984-5, and – what else? – the GFC itself.
Given that NAPM tends to fluctuate in rough synch with business revenues (what else can a boss quickly estimate when he fills in his monthly questionnaire?) and that a plot of its employment component (which saw its largest jump in four years to reach a one-year high) also tends to track that presently anaemic wage fund series we mentioned earlier, it is hard to resist the suspicion that this was nothing more than a rogue result and that it will suffer a similarly dramatic – and similarly inexplicable – collapse next time around.
On top of this, mortgage purchase applications are sharply lower (refinance apps have been cut in half); lumber is falling as multi-family housing starts (domain of the REO-to-Rent speculative crew) have plunged 35% to a level consistent with the last two housing busts; private non-residential construction spending has stalled out, stuck at the same levels as a year ago and 30% blow the bubble highs; and West Coast container trade flows have declined.
Nobody may wish to believe it, but it just might be that the US economy has seen its best for this phase of the cycle.
Where does that leave assets? Arguably overpriced and overbought.
The Value Line, equally-weighted average has just touched yet another new high, up almost 40% since mid-November in a run which has not even seen a correction of more than 5.2%. There it stands supreme, some 60% over the pre-Crash peak and no less than three times what now look like the Tech Bubble foothills. In doing so, since the Age of Irrational Exuberance began with the second half of the ‘90s, the index has outstripped revenues by a factor of more than four.
Meanwhile, the VIX has swooped to a low only once briefly undercut since before the last New Era started to lose its lustre in early 2007. As a result, our ‘Blue Sky’ index – the OEX divided by the VIX, being an inverse representation of what people perceive to be the worth of buying price protection— has jumped to the upper third of the ninety-ninth percentile of the past quarter-century’s distribution, an anoxia-inducing plane only briefly exceeded just as the first rumblings of the forthcoming doom started to afflict the Boom in the March of 2007.
A growing, if still not yet critical, concern is the fact that while stock yields are falling (multiples are expanding), those on bonds are heading northward. In the US, this has meant that BAA bonds are their least expensive vis-à-vis equities in three years, if still well below the last three decade’s norms.
More intriguingly, the total return ratio between the MSCI World and the JPM Global Aggregate has completed a 4-1/2 year, 100% run since the 2009 depths, exactly as it did between 1995-99 and 2003-7, a move which culminated both times in a major stock market top.
As we have remarked previously, margin debt—whether outright, less credit balance or minus mutual fund liquid assets is near previous bull market peaks. But perhaps the most compelling of all is the constant-dollar price of Sotheby’s shares, BID/CPI. An infallible sign of a major asset bubble, this indicator hit almost identical peaks in 1989, 1999, and 2007 and fell 5% or so short in the Great Reflation to spring 2011.
After a 40% run in the stock price since mid-April (25% in the last six weeks alone), this gauge is now nosing well up above the snow line. Sold to the gentleman in the red braces!
Since our last attempt at a textual analysis of where the economic pain threshold lies for China’s rulers, the intervening period has been punctuated by a flurry of meetings, pronouncements, prognostications, and policy precursors.
The net result? That anxieties are certainly rising; that there are some signs of intense political manoeuvring; but that Xi and Li have so far largely stuck to their guns.
Taking the politics first, two items stand out: the news that court proceedings will shortly commence against the disgraced Bo Xilai – wherein he will face charges mostly relating to corruption and the abuse of power – and the post-dated report of a meeting with Henry Kissinger at which former President and éminence grise, Jiang Zemin, fully endorsed the policies of his successor-but-one.
The timing of the first seems nicely calculated to neutralize critics on the left of the party and to preclude any haggling over Bo’s fate from taking place at the upcoming Beidaihe party summit, thus leaving the agenda free to thrash out the nitty-gritty of economic policy ahead of the crucial autumn Plenum.
The second, by contrast, seems to rule out any open, factional divide between pro- and anti-reformers and, taken with Xi’s subsequent re-iteration of his call to ‘deepen reform and opening up’, provides another re-run of the manner in which Deng Xiaoping outflanked Jiang himself on his famous ‘Southern Tour’ of 1992 (an event symbolically commemorated by Xi on his scene-setting first excursion from Beijing after being sworn in as General Secretary in December).
On that earlier occasion, Deng ringingly declared to the back-sliders who were threatening to unravel his grand designs that ‘whoever does not support reforms should step down’ – an implied threat whose resonance will surely not be lost on any of today’s doubters.
Categorizing this as a ‘strategic decision’, last week Xi urged ‘a spirit of reform and innovation’ and for the Party to display ‘ever more political courage and wisdom.’
‘China must break the barriers from entrenched interest groups to further free up social productivity and invigorate creativity,’ he went on. ‘There is no way out if we stay still or head backward.’
Again, the official press coverage of Tuesday’s Politburo meeting was replete with the usual litany regarding fine-tuning, prudent monetary policy, fiscal adjustment, greater efficiency, scientific developments, etc., etc. But, again it emphasized that macro policy should be stable (read my lips: ‘no – monster – stimulus’) and micro policies should be active.
Along these lines, Premier Li had already unveiled a mini-package which sought to ease taxes on SMEs, to expedite the formalities associated with the export trade, and to move up consideration of further railway construction out in the under-developed Wild West of the country. But, far from a reversion to type, this was seemingly so underwhelming that since he announced this, the prices of the likes of steel, coal, aluminium, and copper have severally resumed their slide.
Even the resort to fiscal policy seems to envisage a refreshingly different approach, coming as it does with an avowed intent to limit the budget deficit and reduce spending while alleviating the tax burden where possible. Is this a hint that Beijing will pursue a proper, stimulatory austerity of less government on both sides of the ledger in place of the deadening ‘fauxterity’ of less rapidly increasing outlays mixed with swingeing tax rises currently being practiced in the West? One would certainly like to think so.
Taken with the diktat which aims to address at least some of the worst heavy incidences of industrial over-capacity (a move said to be ‘key to restructuring’ in Xi’s own emphasis), the buzzword for policy seems to be what Li termed ‘sustained release’ – i.e., that there will be no big, blockbuster launches if indiscriminate lending or spending, but instead a steady drumbeat of hopefully therapeutic micro-measures.
On top of that, there was an intriguing reference to the idea of ‘enhancing a sense of urgency’ which was closely linked to the vow ‘to firmly grasp the opportunity for major enhancements’. Does this mean that Xi and Li are cleverly playing the anxieties of the moment in order to lessen resistance to their program of change? That through a strategy of masterly inactivity they will first disabuse the hordes of disobedient local cadres and SOE oligarchs of the presumption that they are all Too Big To Fail, leaving them no option but to adapt to the new policy thrust as the only alternative road to promotion and self-enrichment? It would certainly be nice to think so.
Along these lines, it surely cannot be a coincidence that the press has been filled with cautionary tales deriving from the bankruptcy just declared by Detroit. Nor that a veritable army of 80,000 audit officials is being mustered to go out and assess the true level of local government indebtedness across all levels from the smallest township to the largest central city. The result cannot fail to be chastening even if it is deemed not to reach the CNY20-25 trillion which lies at the top end of some estimates. No doubt there will be sufficient violations of central policy, accounting practice, and banking regulation, not to mention outright criminality for the tally to give Xi and Li a powerful means of seeing that their wishes will henceforth be complied with.
Before we leave this issue, there is one broader point which we must make: namely, that this thoughtlessly regurgitated idea that what China needs is more ‘consumption’ and less ‘saving’ is nothing more than yet another dangerous Keynesian canard.
What the country needs – what any country needs – is more consumer satisfaction, agreed! But how this is to be most sustainably (not to mention most equitably) achieved is to ensure that the greatest possible fraction of production is geared to that end above all others. It should then be obvious that this is an endeavour that cannot fail to require investment: rationally-undertaken, market-oriented, ex ante, private savings-funded, entrepreneurially-directed investment of a kind that has been all too lacking in China, perhaps, but investment all the same – and a good deal of it, too, in a country where the average person suffers a standard of living still far below what could so easily be his to enjoy.
So, firstly, let’s be honest and reclassify all the sub-marginal, no-return-on-capital, ‘empty-asset’ ‘investment’ as what it really is – state-led CONSUMPTION and we will at once clear up a good deal of semantic confusion and hence lessen our chance of chasing off down the wrong macro-aggregate pathway.
China’s personal consumption may well be depressed below its potential – though the fact that households appear to save around a quarter of their income is not wholly exceptional in fast-developing countries, for how else is the growth to be funded? No, the real crux of the matter is that China’s collective consumption (largely undertaken by soft-budget SOE’s and deficit-junkie governments) is far too high and so thoroughly lacking in genuine prospective return to be further borne. It should therefore be no part of policy to increase blindly the degree of exhaustive consumption – especially where this is financed via the top-down suppression of interest rates and by wholesale misallocations of a cartelized, ex nihilo creation of credit.
Of course, the making of such a shift will be by no means a trivial task either to initiate or to see through to its end if only because the piling up of IOUs and the complex layering of both direct and hidden subsidies which has enabled so much mindless, Krude Keynesian, Keystone Krugmanite, New Deal reduplication to take place has also provided employment for one multitude, a core of seemingly reliable customers for another, and – alas! – an unavoidable outlet for the hard-won savings of them both. Not only the most shameless and venal of the princelings will therefore have a strong, vested interest in trying to perpetuate the existing schema, however much people may be aware that it cannot be continued indefinitely.
As the stilted language of the communiqués puts it, the external situation is also ‘complicated’- in other words the patterns of trade upon which China and its neighbours have built so much of their recent prosperity are now displaying at best a dispiriting stagnation and at worst an outright decline.
Thailand is a case in point: exports to China thence are back to 2010 levels and are falling at the fastest pace since the Crash itself. For all the ballyhoo about ‘Abenomics’ the specious glimmer of recovery there seems little more than money illusion. Industrial production has started to droop one more while, when rebased in the US dollars which are the regional standard, even exports are sickly – those to the rest of Asia are falling at their fastest rate since the Crash, also, to lie a good fifth lower than they did at the 2011 recovery peak.
No wonder the latest PMI fell 1.6 points to a 5-month low. Among the components, export orders were weak – mainly thanks to China – and there was evidence of a developing margin squeeze. As the report noted:-
Increases in the cost of raw materials due in turn to the yen’s weakness was cited as a key driver of rising input prices, which increased for the seventh consecutive month. Inflationary pressures were evident to a lesser degree in output prices, which grew at a slower pace than in June.
Weak PMIs were not exactly a rare occurrence, either. China, Taiwan, and South Korea all produced multi-month, contraction level lows.
What is perhaps of more concern is that, according to the latest IIF survey of emerging markets, not only were funding conditions in Asia becoming more straitened in the second quarter (in fact there were the worst of the four geographical divisions in the questionnaire), but loan demand was actually falling in all categories except real estate (where else?). Not a happy portent for vigorous second half growth and with it an enhanced call upon resources.
Continued from Et in Arcadia ego
Here we come full circle, for what this essentially presumes is that there exist no means by which to achieve the ready monetization of credit since that insidious process – which is one favoured equally by the fractional free bankers as much as by the central banking school and the chartalists – breaks the critical linkage of sacrifice today for satisfaction tomorrow which is what ensures that we do not overstretch our resources or overextend the timelines pertaining to their employment.
Though we have already touched upon the basis for this affirmation, it is so pivotal to the argument, that I will test your indulgence in trying to bring home the point, once and for all.
When credit is not erroneously transmuted into money, it means that I, the lender, cede temporary control over my property to you, the borrower, postponing my enjoyment of the satisfactions it confers because you have made it plain to me that your desire for it is currently greater than mine. This difference in preference is – like all such disparities – an exploitable opportunity for us both and, recognising this, my existing claim over a specified quantum of current goods is voluntarily transferred to you, meaning I must abstain from its consumption (whether productive or exhaustive) while you partake of it in my place in what is a wholly co-operative and, moreover, a logically and physically coherent exchange.
You, in return, promise to render me a somewhat larger service some specified time hence, as the reward for my forbearance and the price of your exigency. That surplus – what we regard as the interest payable – will therefore be seen to be the price of time not of money, much less of ‘liquidity’ as the Keynesians would have us believe. Hence, it emerges as a phenomenon much more fundamental to our psychology as mortals and to the Out of Eden impatience with which this afflicts us than to any happenstance of the ‘market for loanable funds’. Once you accept this interpretation, you are at once made aware of just what an abomination is an officially-sanctioned zero – or in some cases, a negative – interest rate and you are presumably one step from wondering whether this monstrosity can be anything other than unrelievedly counter-productive.
Next, however, imagine that I take your IOU to the bank and that peculiar institution registers my claim upon its (largely intangible) resources in the form of a demand liability of the kind which – by custom, if not by legal privilege – routinely passes in the marketplace as money. Your promissory note – a title to a batch of future goods not yet in being – has now undergone what we might facetiously call an ‘extreme maturity transformation’ which it has conferred upon me the ability to bid for any other batch of present goods of like value without further delay. It should, however, be obvious that no such goods exist since you have not had time to generate any replacements for the ones whose use I, their lender, supposedly forswore until such time as your substitutes are ready to used to fulfil your obligations, something we agreed would be the case only at some nominated point in the future.
More claims to present goods than goods themselves now exist (strictly speaking, the proportion of the first relative to the second has been artificially increased) and thus the actions we may now simultaneously undertake have become dangerously incongruous. Our initially co-ordinated and therefore unexceptionable plans have become instead a cause of what is an inflationary conflict no less than would be the case if I had sold you my place at the head of the queue for the cinema only to try to barge straight past you in a scramble for the seat in question.
What is worse, is that this disharmony will not be limited to us two consenting adults – indeed, we may both actually derive an undiminished benefit from it – but by dint of the very fact that the disturbance we have caused will ripple through the monetary aether to inflict its pain upon some wholly innocent third party who is blithely unaware of the shift in the monetary relation which we have occasioned with the aid of the bank. In our cinema analogy, the bank has given me a duplicate ticket which will allow me to bump some uncomprehending late-arrival out of the place for which he has paid and denying him his right to see the show.
Monetization in this manner has done nothing less than scramble the economic signals regarding the availability of goods in time and space. Thus it confounds rational economic calculation in the round and so begins to render honest entrepreneurial ambition moot. Such a legalised misdemeanour is bad enough in isolation, but we know that this will be anything but an isolated infraction. When banks can monetize debts, they will: when they can grant credit in the absence of prior acts of saving, they will – indeed, we demand that they do no less out of the misplaced fear that otherwise economic expansion will be derailed.
The truth is, of course, that the greater the number of economic decisions which come to be conducted on such a falsified basis, the higher and more unstable is the house of cards we are constructing on the credulity of the masses, the conjuring tricks of their bankers, and the connivance of the authorities who are charged with their supervision. Worse yet, the feedbacks at work are such that each new card we add to the pile appears to justify the installation of every other card beneath it and the more imposing the edifice grows, the more eagerly we rush to make our own contribution to this financial Tower of Babel and the more frenetically the banking system works to assist us until it finally collapses under the weight of its own contradictions.
To modern ears, more attuned to the rarefied talk of the exotica of credit default swaps, payment-in-kind junk bonds, and barrier options, this may all seem rather laboured and old-fashioned with its parallels to the classical treatment of the ‘wage fund’ and its echoes of the hard money Currency School which fought the great controversy of the 19th Century with its loose credit, Banking School challengers.
For this I make no apology, for much of what we Austrians stand for can trace its roots back to the reasoning first laid out by Overstone, McCulloch, and Torrens in that grand debate, just as our opponents tonight can trace their lineage back to the likes of Tooke, Fullarton, and Gilbart (I might here blushingly recommend to you a modest little tome entitled ‘Santayana’s Curse’ in which I deal with the relevance of the background to that debate to modern-day finance).
It is also important to bear in mind that the game of finance cannot be conducted in a vacuum, to always be clear that its workings exert a profound effect on everyday decision making and that finance is a force for good when the rules of that game are in harmony with those laws of scarcity and opportunity which govern what is loosely termed the ‘real’ economy of men and materials.
Moreover, the elision of these two types of claims – money and credit – by what must be a fractional reserve bank has dramatically raised the stakes. The near limitless, fast-breeder proliferation of credit which this enables and the facile transformation of this credit into money breaks all sorts of self-regulating, negative feedback mechanisms between supply, demand, price, and discount rate. Greater, credit-fuelled demand leads to higher prices.
Higher prices should discourage further demand, but instead encourage more people to borrow in order to play for a further rise in prices, just as it flatters the banking decision to grant such loans since the earlier ones now appear to be over-collateralized and their risk consequently diminished. Divorced from a grounding in the world of Things and no longer intermediators of scarce savings but simply keystroke creators of newly negotiable claims, our modern machinery is all too prone to unleash a spiral of destabilizing – and ultimately disastrous – speculation in place of what should be a mean-reverting arbitrage which effortlessly and naturally reduces rather than exacerbates untoward economic variation.
Sadly, my monetarist and Keynesian rivals see nothing but positives in this arrangement and given their unanimity on the issue, I would hazard a guess that the complex adaptive system types are happy enough to bow to this consensus and to accept that this is simply the way things are when they construct their models and run their simulations. The laymen – even the expert laymen, if I may be allowed such an oxymoron – have been even more united in bemoaning anything which might inhibit banks’ ability to shower credit upon everyone and anyone who asks them for it. If we had no shadow banks, who would give the aspiring taxi-driver the price of his medallion or the wannabe nest-maker her mortgage, one participant asked, as if we all took it for granted that to enjoy goods for which one has not earned the means to pay was their god-given right.
Nor do the free-fractional types, as eloquently represented here by Professor George Selgin, have any objection to the mechanism itself, being, on the contrary, keen to suggest it will do far more good than harm by dampening down fluctuations which they fear may emanate from a suddenly increased to desire to hold money for its own sake. All they ask is that the ‘free’ banks they advocate are forced to come out from under the aegis of a central bank of issue and away from the current fiction of government deposit insurance and so have no-one to shield them from the consequences of any excess or imprudence into which they might stray.
It will probably not now surprise you to learn that while we agree that banks should indeed stand on their own two feet like those involved in any other branch of business, very few of us Austrians share his sanguinity on this issue, either on theoretical grounds or as a result of our own somewhat different interpretation of the (mainly Scottish) historical record.
For our part, we would rather that the kernel of money-proper around which all other obligations are arrayed is both unable to be near-costlessly expanded at political or commercial will or shrunk as a consequence of any wider calamity. Given this fixity, we trust that any change in economic circumstances will see prices adjust to reflect that without occasioning any major harm (our model economy has undergone a radical Auflockerung by now to ensure this). Nor do we believe that credit will be denied all flexibility, certainly not within the dictates of what the saver can be persuaded to accord to the investor, or the vendor to the buyer.
It is true that this would be a world characterized by the slow decline of most prices as human ingenuity and honest entrepreneurship were continuously brought to bear on the eternal problem of scarcity, but neither would this hold for us any terrors. After the initial transition, people would soon become acclimatized to such a benign environment and would adjust their expectations and their capital structures to best fit it.
As for Professor Selgin’s bogeyman of a sudden tumultuous rush to hold money for its own sake – which apocalypse he fears above all should we prohibit his Free Banks from printing up such liabilities, willy-nilly – we see little reason to believe such impulses could reach very far up the pecuniary Richter scale in a society which had wisely denied itself the volatile mix of massive fictitious capital, extreme leverage, inflationary gambling, morally-hazardous speculation, soft-budget public choice profligacy, and reckless maturity mismatches with which we are so afflicted in our present era of easy-money, chronic price-appreciation, and the granting of overarching central-bank ‘put-options’.
Sound money is more likely to prove conducive to sound business practice and hence to a sound night’s sleep for all.
To sum up then, the only valid economics is micro, not macro; individual, not aggregate. Value is subjective not objective. The consumer is sovereign in the choice of where he spends his dollar – and all values can be imputed from where he does so – but he should first earn that dollar through his prior contribution to production.
Entrepreneurial discovery is the evolutionary mainspring which drives our secular material advance and the entrepreneurial profit motive – in an honest-money, rent-free world – is the ‘selfish gene’ of that ascent. That same motivation mobilizes the set-aside of thrift in the form of capital and capital – to risk pushing the biological metaphor beyond the point of useful illustration – is the enzyme pathway leading to the synthesis of what it is we most urgently want at the lowest possible cost.
In all of this, the workings of a sound money should be so seamless and subliminal that we pay it no more attention than we do the fibre-optic networks or 4G radio waves used for the transmission of our digital data. Finance should be based on funding – i.e., the sequencing and surrender of the right to employ real resources through time.
That economics is an Austrian economics, not a monetarist one, a Keynesian one, nor a complex-adaptive system one and I heartily recommend it to your consideration.
Continued from Been there, done that, bought the T-shirt
Having broadly tried to demonstrate where we differ from our rivals and where we find their tenets most objectionable, you might be hoping that I will now be tempted to go into the details of what an Austrian might recommend by way of a remedy for our current ills even though this would exhibit a clear infraction of Hayek’s admonition that ‘the curious task of economics is to demonstrate to men how little they really know about what they imagine they can design’!
So, rather than having me succumb to such a ‘fatal conceit’, let me instead sketch the outlines of what would, in an Austrian estimation, be a world in which we would be unlikely to repeat our present stupidities, certainly not on the Olympian scale on which we currently practise them.
Firstly, we should recognise that much of our success as a species comes from our adherence to that peculiar form of competitive co-operation which we Austrians term ‘catallactics’ – i.e., the business of exchange, of trading the fruits of our varying endowments, aptitudes, and accomplishments to the mutual benefit of both counterparties to what may well be a single-priced transaction but which is nonetheless never a zero-sum one (at least when it is undertaken voluntarily and in good faith).
As a direct consequence of this, we can assert in the strongest possible terms that we therefore tamper with the means by which we conduct such dealings – we meddle with our medium of exchange, our money – only at our peril. To us, dishonest money is the root of all evil, not ‘shadow banks’, ‘moral hazard’, ‘regulatory capture’ or any of the manifold offshoots of human cupidity in general, for the ability of such perennial failings to wreak widespread havoc in either financial markets or economies, per se, would be much more severely limited if money were not so easily corrupted alongside the men who use it.
A good deal of discussion has taken place at this gathering and many ideas have been thrown up – many of them earnest, most of them shrewd, some of them even practicable – as to how to improve our present modus operandi. But unless banking and finance better reflect economic reality – and by this I mean of course Austrian reality! – all of them will be in vain: not so much shuffling the deckchairs on the Titanic as pruning the vines growing on the slopes of Mt Vesuvius, perhaps.
It should be further recognised that a vital subset of our economic interactions consists of that swap of jam today for jam, not just tomorrow, but for a long succession of tomorrows that we might more grandly term ‘intertemporal’ exchange. Indeed, it can be argued that this process is even more intrinsic to our humanity: that the move away from such hand-to-mouth activities as scavenging, foraging, and predation and towards the rational provision for the future by means of forward planning is very much what put the sapiens into the Homo, way back when Also sprach Zarathustra was first ringing out as the soundtrack to Mankind’s great Odyssey from the campfire to the Computer Age.
It is in this devotion of forethought and its associated deferral of immediate gratification where the concept of ‘capital’ first comes into our story and while this opens up before us a vista of riches bounded only by the interplay of our imagination and our willingness to make a short-term sacrifice in order to gain a longer term advantage, it is intrinsically fraught not only with estimable risk, but with unknowable uncertainty, as well as being subject to the further proviso that our own actions’ influence may well serve to increase the range of possible outcomes far beyond what we had first thought likely.
Keynes himself waxed lyrical about the ‘dark forces of time and ignorance’ – even if his own teachings have done more than most over the intervening years to enhance the occultation and obscurity against which his fellow men would have to contend – so it should not come as a surprise when we next insist that none of our man-made institutions can be said to be well-crafted if they aggravate these difficulties.
Economic institutions should thus allow information to percolate in as uncorrupted a manner as possible and should allow for feedback signals to be generated in as direct and unequivocal a fashion as they can. These should clearly flag where both success and failure has occurred so that useful adaptations can proliferate while the ineffective ones are abandoned as rapidly as can be. In essence this means that we must not pervert prices and, since every price is necessarily a money price, the unavoidable inference is that we should not mess with money.
A corollary to this is that there should be the least possible impediment to any and all such adaptations being attempted; indeed, much Austrian ink was spilled during that dark decade of the 1930s in arguing that the surest remedy for the many ills then afflicting the West was to sweep away the obstacles to change and to lubricate the working of the machinery – to practice a policy of Auflockerung, in the phrase of the day.
Following on from this, it should be evident that property should be inviolate and the wider rules of contract should be both transparent and consistent in their application. The law should be concerned principally with equity, the courts with providing a cost-effective and disinterested forum for the arbitration disputes arising from any violations of the first and of any failure to fulfil commitments freely made under the second. Aside from the many ethical considerations attaching to such a demand, we would argue for it additionally in terms of the need to reduce all the uncertainties under which men must act to their achievable minimum if we are to encourage the widest degree of peaceful association, the richest web of commercial relations, and the greatest degree of capital formation that we can.
What we do not want is to be inflicted with a shifting snowball of often retro-active regulation. We must avoid a diffusion or supersession of individual responsibility and desist from fuzzy, catch-all law-making – in fact, we should tolerate as little legal positivism as possible, especially of the kind enacted, often cynically, during periods of crisis. We must insist that the state offers neither explicit nor implicit guarantees, that no bail-outs, or back-door favours be extended to the privileged few at the expense of the disenfranchised many. Finally, it should be impressed upon our elective rulers that the politics of disallowing loss, however well-intentioned, is nothing more than a policy of disavowing gain.
Though there are wider ramifications, the worlds of money and finance should, of course, be subject to all the above strictures. Here, we would again emphasize that to interfere wilfully with the substance of our money is to put oneself in breach of most of these guidelines; indeed, that this is perhaps the most heinous of all infractions, since it entails the most pervasive attack upon both property and the sanctity of contract that there can be since it involves a post hoc and highly arbitrary change in the dimensions of the very yardstick by which the terms of all such agreements are drawn up.
We would further contend that the paving stones on our road to the future, on the intertemporal highway whose praises we have already sung, are nothing more than our investments. These should be funded with scarce savings, not financed by the paltry fiction of banking book entries and hence the business of investment should be conducted only in accordance with the balance we can jointly negotiate between our current ends and our ends to come; that is, on a schedule which naturally emerges to reflect our societal degree of time preference and which does not emanate solely from the esoteric lucubrations of some central banking Oz.
Progress may be less spectacular this way, unpunctuated as it will be by the violent outbreaks of first mass delusion and later disillusion which comprise the alternations of Boom and Bust. But it will be, by that same measure, steadier and more self-sustaining. Absent such a condition, the fear I have already raised is that all the well-meaning calls for better financial regulation and more condign penalties for banking malfeasance are so many straws in the wind as far as a better functioning financial apparatus is concerned.
In passing, the very fact that we are all gathered here to bring so much effort and expertise to bear on the problems thrown up by our contemporary methods of finance shows just how far we have strayed from a true appreciation of its abiding scope as what is effectively little more than a glorified, if somewhat disembodied, form of logistics. Finance should be a record of the assignment of goods and property rights across time and space – a four-dimensional bill of lading, as it were. It would be better were it seen for what it is – a means and not an end; the flickering reflection of a deeper Reality on the wall of Plato’s cave, not a towering 3D IMAX rendition of a screenwriter’s imagining. It should once again be valued only as the carthorse and not as the cargo he pulls behind him.
This article is the fourth in a series. The final instalment will follow shortly.
Continued from Scylla & Charybdis
The guilty secret shared by many disciples of these two schools is that they are well aware that theirs is very much a busted flush, as is made plain by the procession of very public breast-beatings and existential re-examinations which they have conducted in the years of post-Lehman purgatory by way of atonement for their failures. Indeed, one measure of the dissatisfaction felt at the failings of these Terrible Twins – the money illusionists and the flushing-toilet hydraulicists – lies in the attention now being focused on the work being done by my third opponent and his peers under the guise of the ‘complex adaptive system’ approach.
To an Austrian, in truth, there is much about this last that seems thoroughly unobjectionable, so much so that it is hard to resist an invocation of Gunnar Myrdal’s trenchant dismissal of Keynes’ for his linguistically-challenged commission of the sin of many a monoglottal, English-speaking economist – that of ‘unnecessary originality’.
I say this because in many ways the Complexity guys are simply putting a computer-age spin on concepts we have been trying to articulate for the past three generations.
We, too, start from the bottom-up by focusing on the individual – or the ‘agent’ as he is now known. We, too, believe that order is emergent, knowledge is dispersed, network effects are key, and that the attainment of equilibrium is a mirage.
Where I suspect we differ is that we are more radically subjectivist in a way that it cannot be possible to capture in a mathematized ‘model’. One might also be dubious about the degree of ‘scientism’ involved – i.e., the extent to which there has been an invalid application of the precepts of physics to what is after all a social phenomenon. One might also be wary of the inherent dangers of being too prescriptive in laying out what the ‘agents’ may or may not do.
Among the caveats is the fact that we Austrians hold that scales of preference and utility are ordinal, not cardinal, and so are not arithmetically tractable. Moreover, we cannot see it as a complete solution to go to the trouble of atomizing what was formerly a faceless, monolithic ‘aggregate’ only to have to deny the atoms their own individuality, however capricious their expression of this property may be. We must be wary therefore of driving out the ghost and leaving only the machinery behind.
Nor do we then want to thrust our poor little cellular automata into a Game of Life whose inevitably arbitrary choice of rules is predicated on the very same contradictory framework from which we are trying to free ourselves – namely, the one prescribed by the traditional schools of macromancy. Not only would we wish to avoid our agents’ freedoms being prejudiced by the suppositions of the mainstream, we would also wish them to do more than play out a mere financial simulation, however rich it might be in revealing the structural flaws in our existing institutional architecture and in warning us of its proclivity to the negative feedbacks, price cascades, and other malign outcomes which have come to plague it.
For us, a better imagined microcosm would include scope for the real-world action of entrepreneurs, those principal vectors of eco-genetic adaptation and selection, those drivers of change and arbitrageurs of profitable possibilities, the men and women who are constantly seeking out new combinations of action and innovative mixes of things in order to deliver more value at lower cost to a wider range of customers. Any toy universe which leaves out a reasonable representation of entrepreneurial endeavour – and the fact that this quintessential force for betterment thrives best in conditions which lie outside the bounds of equilibrium, yet away from the ragged edge of chaos – is likely to produce a poor facsimile of the real economy.
Our stipulation for an improved virtual landscape would also insist it addresses a major failing of mainstream macro, viz., its poor handling, if not outright neglect, of the role of capital – a critical construct which is neither a financial variable (despite the unfortunate overlap of terminology with the world of book-keeping) nor, strictly, a mere physical entity like a factory or a machine tool, but which is rather a hybrid which includes both the use of the Thing and the process by which it is employed such that ‘capital’ becomes as much a verb as a noun, if you will.
It may be that we do a disservice both to the judgement and the ingenuity of our Complex System friends, but it does seem questionable that the kind of ‘experts’ they are likely to have consulted would have advised them to incorporate such features when writing their programs just as it is beyond our ken as to exactly how they would go about doing so, even if asked.
If it really is the case that either they have not or they cannot, theirs must very much still be considered a work-in-progress and not yet a fully-formed tool of analysis.
This article is the third in a series. Continue to Part 4: Et in Arcadia ego.
Continued from The Divinity School debate.
The devotees of monetarism start from the observation that what they call ‘money’ tends to move in a loose correspondence with a statistical chimera called ‘National Income’ and then proceed to reverse the usual order of the harnessing of cart to horse to suggest that this income is best controlled by manipulating the quantity of ‘money’ ex ante (and here let us spare ourselves an examination of the exact definition of that beast, in keeping with the monetarists’ own proclivity to flit promiscuously between whichever of the likes of M1, M2, M3… M(n) currently best fits the econometric bill).
Leaving aside the vexed question of what exactly comprises ‘national income’ or of whether the near infinite richness of the interactions taking place between tens – if not hundreds – of millions of people can be boiled down into one simple numerical entity, it is not really surprising that, in a horizontally-diverse, vertically-separated, modern economy, the multifarious business of accumulating, transforming, and delivering a wide array of goods and services involves the generation of a commensurate number of claims so that each individual’s part in the creation of this bounty can be duly recorded and ultimately encashed.
But it is a long way from recognising that a degree of correlation might exist between money and credit on the one hand and material wealth on the other to insisting that the forcing of extra claims upon the system can somehow encourage an increase in genuine business, an augmentation of prosperity, or a sustainable improvement in the common weal.
To believe that wonders can be enacted merely by tinkering with the availability of the medium of exchange which is our economic system’s basic plumbing is a bit like the brewer who thinks that his beer can be made to ferment quicker and taste better if only he can lengthen the span and widen the bore of his pipe-work, or like a would-be author who thinks his magnum opus is more likely to be recognised as a literary masterpiece if he doubles the spacing between the lines of his typescript and so uses twice the number of reams of paper to set it down.
This is not to say that we Austrians deny that such jiggery-pokery can have very real effects on the economy – we are, after all, the ones who are noted for our own, unique, Monetary Theory of the Business Cycle – but we do doubt that its effects are either so mechanically predictable or so universally benign as our esteemed Chicagoan colleagues suppose.
Furthermore, we are all too aware that the monotonic and comprehensive inflation of values which results from the kind of carpet-bombing, ‘helicopter drops’ which loom so large in the dark fantasises of our central banking chiefs are not the norm, but that money creation takes place at specific times and specific places and so raises some prices and enhances some demands before it effects others, thus causing all manner of largely incalculable disruptions to the all-important relative price relations which are the means by which we can determine how scarce one good is compared to another. Thus, each of their successive interventions is only likely to introduce further strains into what the earlier ones have made an already highly dislocated structure to the point that the malign effect of such distortions seems to require yet further acts of interference with the natural order.
As for the Keynesians – one almost fails to know where to begin with a hodge-podge of obscurantism which is at best a rehashed version of the old under-consumptionist fallacies, shot through with a dash of equally antediluvian mercantilism, and at worst a cynical excuse for central planning and an assault upon the sphere of private decision making.
Not the least of the sins of dear Maynard was his role as a ‘terrible simplificateur’ in his championing of a school of accounting tautology that too many of us have come to revere as ‘macroeconomics’ – a many-headed monster of a thing which all too often tends to controvert the eminently sound insights of micro-economics once the latter’s transaction count crosses some strange, reverse quantum threshold of weirdness.
We have heard some of the peculiar effects of this tendency here tonight in being assured, among other things, that the only salvation of a people brought low by borrowing too recklessly is to find another agency – Burckhardt’s arch ‘swindler-in-chief’, the state, if no one else – to take their place at the high table of prodigality.
We have also been told that public debt is an ‘asset’ that we owe to ourselves – a contention which not only flies in the face of logic, but also of much of history – and that we cannot all export our way out of difficulty, when the very marvels of modern society have been exactly so built up by each man, much less each nation, ‘exporting’ as much value as he can to his fellows, thereby earning the right to ‘import’ as much as he would like from them as his due reward.
Above all, we have been enjoined to assume that everything wrong in the outmoded world of laissez-faire is the consequence of someone – usually someone assumed to reprehensibly better-off than the norm – failing either to exhaust the entirety of his income on fripperies – so triggering a nonsensical ‘paradox of thrift’ – or to spend any such surplus of income over outgo on fixed income securities – so delivering us to the legendary Château d’If of the ‘liquidity trap’ instead.
Needless to say, we hold the opposite to be true. We hold that thrift fuels, rather than frustrates, material progress and that the only ‘liquidity trap’ we have to fear is the snare that results from the provision of too excessive a supply of ‘liquidity’ – i.e., of a great superfluity of money and the promise of artificially cheap credit for ‘as long as it takes’ – in the aftermath of the Bust. This utterly wrong-headed approach only attenuates the purgative effect of the crash and so leaves too many men, machines, and minerals locked into too many failed endeavours at what are still too-elevated prices for their redeployment to alternative uses to promise a decent return on the undertaking, this preventing economic rejuvenation.
In the authorities’ Humpty Dumpty compulsion to validate every sunk cost by suppressing interest rates – and thereby suppressing a good deal of the useful risk appetite and channelling too much of it into the narrow field of financial speculation – they only succeed in sapping the survivors of their remaining vitality. On the one hand denying the least afflicted (among whom are to be found, by definition, our potential saviours, the wiser, the more resilient, and the more flexible) the opportunity to rebuild amid the rubble, they thereby hand the reins instead over to an enervating alliance of extractive, public-choice parasites, skulking subsidy-grubbers, feckless leverage jockeys, and special-pleading, sub-marginal zombie companies
Among other enormities, the fact that production must necessarily precede consumption and that it is the first which comprises the creation of wealth and the second which encompasses its destruction, was far beyond the ken of the spoiled Bloomsbury elitist who exhibited a life-long contempt of the aspirations and mores of the bourgeoisie and who hence imagined that policy was at its finest when, like an over-indulgent aunt, it was pliantly accommodating the otherwise ‘ineffective’ demand being volubly expressed by the old dame’s petulant nephew as he stamped his foot in the tantrum he was throwing up against the sweet-shop window.
This article is the second in a series. Continue to Part 3: Been there, done that, bought the T-shirt.