Once again, the European press is trumpeting the triumph of the prodigals after a week in which both the Spanish and the French were accorded more time to get their budgetary house in order – a move which, given the downward economic trajectory of the pair, has something of a whiff of force majeure about it – and the German Finance Minister Schaeuble acknowledged that, yes, the fiscal pact around which he and his boss have built so much of their electoral credibility did in fact encompass a ‘certain flexibility’.
In the wake of a mass demonstration on the streets of Paris at which the Left Front’s heavily-defeated presidential candidate Melenchon fulminated that “We do not want the world of finance in power!” – an expostulation delivered to the strains of ‘Ca ira!’, one supposes – Schaeuble’s Gallic counterpart Moscovici was hardly in a position to soft-pedal the German concession, instead vaunting grandiosely in his turn that, “We are witnessing the end of the dogma of austerity… we are at a decisive turning point in the history of the European Project”.
Brave words, indeed, but Frau Merkel, for one, begged to disagree – or, at least, to dissemble for the benefit of her domestic audience. “If one regularly spends more than one earns, something must be awry,” she opined, while one of her party’s spokesmen, Steffen Seibert declared that, “Our contention is that the… crisis has its roots in the overindebtedness of many member states… in to low a degree of competitiveness.” No prizes for guessing to whom he was referring.
Last week’s supposed poster boy for the new laxity, Commissar – sorry, Commissioner – Barroso, was also out on the circuit, denying that he had endorsed any such slippage by telling Welt am Sonntag that he had been “deliberately misinterpreted”, that – au contraire, mes amis – “growth which depends upon debt is unsustainable” and that the blame for the ‘Project’s’ woes should not be pinned on German policy but rather on “excessive outlays, lack of competitiveness” – that word again – “and irresponsible finance.” “Each nation,” he went on, “should look to clean up the mess on its own doorstep.”
Amid all this posturing, it does strike your author as a touch ironic that while the commentariat treats Europe’s persistence with its failed experiment in ‘fauxterity’ as a clear and undeniable symptom of the mental inadequacy of its ruling elite, the members of that same consensus themselves retain what is, if anything, an even more delusional faith in the combined evils of inflation and Big Government as the magical means with which to conjure away all our present woes.
In case you hadn’t noticed, fellas, we have been reinforcing monetary-fiscal failure for the past five years, by continuing to ply the patient with ever stronger doses of what it was that made him ill in the first place. Just multiply the DAX by the youth unemployment rate if you want a snapshot of where your approach has gone horribly wrong – of where you have let the GINI out of the bottle, as it were – and you might realise that if there is anyone who needs to reconsider their attachment to a discredited dogma, it is you!
Whisper it, but even your hero seems to be getting the drift. For witness that, in his latest speech in Rome, Mario Draghi was happy to say that “Fiscal policies must follow a sustainable path, separate and distinct from cyclical fluctuations. Without this prerequisite, lasting growth is not possible… Particularly for countries with structurally high levels of public debt…”, before going on to assert far more boldly that – as we have said since Day One of the crisis – “…to mitigate the inevitable recessionary effects of fiscal consolidation, the composition of such measures must favour the reduction of current public spending and of taxes, particularly in a context such as in Europe where taxation is already high by international standards….” [our emphasis].
Though we must be careful not to read too much into the man’s words, it is hard not to hope that this might reflect the first fragile flowering of a genuinely new approach – of the inauguration of a policy of REAL austerity, this time of the invigorating kind which incorporates a partial lifting of the deadening hand of the state, rather than the enervating, bastardized version of slower spending growth and rapidly rising taxes with which we have been so far afflicted and which has only served to compound the financial shock delivered by the collapse of the last bubble.
All this remains to be seen but, in the here-and-now, the temptation to use this effusion of political hot-air as an excuse to buy yet more stocks, more ailing sovereign debt, and more junk credit has become well-nigh irresistible, especially since Super-Mario not only overrode what he hinted was some internal opposition to an official rate cut at the latest ECB meeting, but also managed to leave dangling before a slavering crowd of stimulus junkies a tantalising hint that he might soon push the level below zero. In case we were too obtuse to get the point, he underlined his intentions with another of his famously portentous, almost Delphic pronouncements: that even though the ECB council was still scrambling to divine whether anything could possibly go wrong with such step into the unknown, he, Draghi, stood ‘ready to act’.
It was not the first time in recent days, of course, that the marbled halls of Mount Olympus had echoed to the sonorous baritone of the Gods as they sought to reassure us poor mortals that they had matters well in hand: that they had taken time off from their weighty contemplation of the sublime, the eternal, and the infinite to tend instead to our petty concerns. Had not the Bernanke Fed subtly quashed all thoughts that it might soon ‘taper’ its own open-handed distribution of milk and honey with that one, equally Pythian phrase: “the Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation”?
How can a man NOT want to buy the market in the face of the solicitous stance being taken by the venerated possessors of such unchallenged omniscience?
For all this, the imposition of the near-mythical, negative deposit rate might seem to entail more problems than advantages, not least because it would effectively act as a tax, a drain upon the earnings, of the very same banks that the last five year’s ruinous policies have been attempting to bolster. Bear in mind that, even after the recent redemptions, European banks have a hefty €628 billion parked with the ECB and so a 50bp levy on this could amount annually to perhaps 15% of industry-wide profits.
Nor can banks simply avoid this by withdrawing their funds: outside money – the kind created by the central bank – is, after all – outside. This means that its supply can only be altered with the complicity of the bank of issue itself which must therefore allow its myrmidons to pay back more of their LTROs, covered bond repos, and so forth – a reduction of liquidity which one might think would run counter to the original intention. Thus, one supposes, the idea will be that the banks will enact the Gesellian wet dream of passing on the cost to their own depositors, of taxing their money instead.
Here we must consider the fact that while the individual can easily seek to disembarrass himself of what he now considers an excess proportion of money among his holdings, collectively the public can only have their aggregate stock of inside (bank-created) monies diminished in one of three ways: they must repay their loans (deleverage further); the banks themselves must call in said loans (intensify the crunch); or people who hold a demand account must swap it for a term deposit (which does not constitute money-proper), or invest in a long-term security issued by the bank itself (we specify this last because a moment’s thought will reveal that the purchase of non-bank paper simply passes the parcel to the seller or issuer of said obligations who must then rid himself of them in his turn).
While that latter condition might seem an ideal juncture at which the banks could seek to boost their levels of capital (albeit at an average price:book of significantly less than one), the truth is that what the authorities seem most keen to provoke is a what is technically called a ‘monetary disequilibrium’ – that is, the situation where the public’s demand to hold money is thrown out of kilter. Under such conditions – and given the nominal inflexibility discussed above – the money stock can only be effectively reduced if its real value falls; if prices rise and so reduce its worth; i.e., if there is an inflation.
In that regard, the impulse to buy stocks on what is no more than a vague expression of intent might not seem so wholly irrational, after all. To see this in what is admittedly a toy example, suppose that half the population holds only cash and no equities (call these sticks-in-the-mud Group A), while the remainder has a reverse proportion of all equities, no cash to an equal overall nominal value held in their portfolios (call the ‘Nothing but Blue Skies’ crowd, Group B). The aggregate cash ratio from which we start is therefore 50% (albeit thanks to a not-to-be-exceeded and somewhat unrealistic divergence of preferences between our two cohorts).
Now suppose the members of Group A change their outlook on life and seek to acquire equities from Group B, paying successively higher prices for ever smaller increments in order to tempt their counterparts into the trade. Under some fairly crude assumptions, after four rounds of such bidding, with one third of the stock of equities having exchanged against two-thirds the stock of money, equity prices will have tripled, the cash ratio of both groups will have converged on 25%, and aggregate net worth will have doubled (to the relative advantage of the initial equity holders, but to the outright, if decidedly notional, benefit of all).
Note, however, that none of this says that the equities are worth three times as much for even if the monetary disturbance has somehow meant that earnings have also tripled (and this is far from being guaranteed even should revenues rise in proportion), this may represent no material gain whatsoever, but only register the inflation of a wider range of prices which here has not been consequent upon an increase in the stock of money per se but solely upon a diminution in its societal valuation.
Herein lies the great gaping hole at the centre of official policy. Yes, the central banks can increase the stock of outside money almost without limit. Yes, they can make it as unattractive as possible for anyone to hold this (though when we come to think about the impact of negative rates, let us not forget that people are generally happy to pay to have their other valuables safely stored, or that bank charges used to be a routine imposition upon the short-term depositor). And yes, to some extent they can assume that their actions will enhance the relative appeal of things other than money or its partial substitutes.
But what they cannot ever gauge is how much influence they can exert, nor how quickly their will may be done, nor even upon what specific mix of goods, services, or claims their policy will have most impact. As the great Richard Cantillon pointed out three centuries since, the whole question is highly path dependent and the path actually followed will be the result of an incredible cascade of interactions between individual, subjective choices, each one altering the quantum field in which the next has to be taken. As we Austrians have been saying for the past one hundred years, this affects relative prices much more profoundly than it does average ones. Crucially, it is in that matrix of relative prices that you find the motivations for all economic actions and the justification or otherwise for both the composition of the capital stock and the distribution and employment of labour. If entrepreneurial uncertainty and personal bewilderment have been major contributors to our ongoing malaise, as many of us have been arguing, it should be clear that we seek to introduce further sources of instability and potential disruption only at our peril.
Nor can our Sorcerer’s Apprentices be entirely sure that, as the demons they have summoned out of the vasty deep continue to chip away at the foundations of trust in the very currency which they, the necromancers, are charged with upholding, they do not unleash a catastrophic collapse of the whole superstructure of values and contractual chains which towers above them, reducing the whole economic system to chaos in the process.
If you can convince me that any mortal can hold such a complex tangle of possible outcomes within their comprehension, I will allow that our monetary heretics may be right to do away with the combined practical experience and theoretical understanding of all those who have gone before them over the ages. Until you do, I shall be forced to withhold my endorsement and to mutter darkly about the unexpiable sin of hubris instead.
Under President Obama the debt of the United States government has grown by about 50%, and now stands at close to $16 trillion. Every year, the US government spends between $1.2 and $1.5 trillion more than it takes in. Every day that financial markets are open the US government has to borrow an additional $4 billion.
The pathetic fiscal cliff ‘compromise’ of last week has proved the most cynical students of the political elite correct in that there is not a snowball’s chance in hell that Washington will ever get this under control.
Can this go on forever? No, it cannot — although adherents of the Church of Modern Monetary Theory now proclaim that its holiness, the State, is not restricted by earthly matters, and that no limits apply to it. “It simply prints the money!” Back on earth, however, such recklessness has consequences, and these consequences will ultimately put a very nasty end to proceedings. But politics will not fix this. This much is certain.
One of the annoying little things that stand in the way of more debt is the dreaded debt ceiling debate, a quaint congressional tradition according to which the politicians in Washington have to periodically pretend that they can indeed exercise self-constraint and that they would even obey self-imposed limits. After the usual self-serving theatrics, both parties agree that the debt ceiling should be lifted, that spending must continue, and that more debt should be accumulated – in the interest of the American people, the US and the global economy, social peace, and because the show must go on.
Since March 1962, the debt ceiling has been raised 74 times.
Enter The Coin!
In order to make this farce a tad easier next time, the following plan has been concocted. It has recently made the headlines. You can read about it here and here:
The U.S. treasury is to issue a platinum coin with a notional value (that is, a value that is fixed entirely arbitrarily by the government) of $1 trillion, and this coin is deposited with the Federal Reserve. In fact, the coin is used to pay down $1 trillion of US government bonds held presently by the Fed (The Fed holds more than $2 trillion in government bonds). Thus, tradable government debt that counts against the debt ceiling is swapped for a ‘commemorative’ coin that does not count against the debt ceiling. $1 trillion of government debt thus magically disappears.
The US government has its fans who believe that anything, legally or illegally, should be done to keep it living beyond its means for as long as possible. These fans are supporting the plan. Among them is, not surprisingly, Paul Krugman, who fears nothing more than a congressionally enforced coitus interruptus before the protracted orgy of money-printing and deficit-spending has a chance to climax – as he keeps promising us – in a wonderful return of self-sustaining growth.
But the plan has many critics. Their criticism strikes me, however, as rather naïve and faint, and also missing the true significance of it all.
The critics make the following points:
1) This is just a trick and may not be legal.
2) It eases the pressure on politics to reduce the deficit meaningfully.
3) This could lead us onto the dangerous road toward debt monetization and could be inflationary.
Let me address each of these points before I come to what I consider the most important aspect of this.
Ad 1): Oh pleeeeze! Is it a trick? Is it a gimmick? Could it be illegal? – Are you stuck in the 1980s? – Of course, it is a trick and probably illegal! But who cares? Please get real. We have long passed the point at which any of the major governments feel constrained by such things as constitutions, laws, contracts or past promises. We live in a time of ‘anything goes’. Remember: “We will do whatever it takes!”
Look at Europe: From the start of the European debt crisis to today, EVERY rule that was set up at the start of EMU in order to govern it and to discipline its members, has been violated, ignored or shamelessly re-interpreted. The political class is making up its own rules as it goes along. Parliaments are rubber-stamping everything, and if they hesitate they are told that they could be held responsible for the ‘next Lehman’. Sign here, or else….
As I explained here, the US government has already abandoned habeas corpus, has arbitrarily annulled private contracts and will force Americans into commercial transactions. You think they will stop at the laws governing the issuance of commemorative coins? Do you really think that the army of lawyers that works for Washington cannot come up with a reasonably acceptable explanation (read: this side of totally laughable) for whatever the government wants to do that will sufficiently appease the folks at Harvard Law Review?
We may not get this specific version of the plan but something similar will certainly be implemented in the near future. You can bet on it. It is simply in line with current modes of thinking and the present political culture – or lack thereof.
Ad 2) The politicians will feel less pressure to enact real budget reform. – Oh come off it! There is neither real desire nor ability nor the required character and decency among the political elite to fix this self-inflicted budget mess. If you needed a reminder of the spinelessness and stupidity ruling Washington you only have to look at the great fiscal cliff compromise that was reached last week and that the equity market, evidently still on a drug-high from snorting unlimited lines of free central bank money, has been celebrating deliriously ever since. Let me say this in reference to a great quote by the incomparable P.J. O’Rourke: To expect Washington to reform itself and rein in spending is akin to giving your car keys, your credit card and a bottle of Jack Daniels to your 17-year old son and expect him to act responsibly.
Ad 3) Could this be the start of debt monetization?
Debt monetization has been going on for years, is alive and kicking, and gets bigger by the day. In the US and Britain, the central banks are the largest holders of their respective governments’ debt and the largest marginal buyers. The Bank of England has monetized about 30 percent of outstanding debt and now has more UK Gilts (government bonds) on its balance sheet than the entire UK pension and insurance industry combined. Under its current program of ‘open-ended’ QE3 (or QE4, or QEwhatever) the Fed buys $85 billion worth of new Treasuries and other securities every month.
Let’s get this straight: The whole raison d’etre of central banks is that they print money to fund the state. The Bank of England – the mother of all central banks – was set up specifically for this purpose in 1694. Since then a whole list of elaborate excuses has been drawn up for why central banks are needed and useful, a list that looks more ridiculous by the day: Central banks control inflation and guarantee monetary and economic stability? The exact opposite is true: Central banks create inflation and cause monetary and economic instability. There is no escaping the conclusion that they are organs of state planning and systematic market manipulation and thus fundamentally incompatible with the free market. But one true purpose remains: funding government. Increasingly, it is the dominant function of the ECB, the Bank of Japan, the Bank of England, and the US Federal Reserve to secure cheap credit for their respective governments and their out-of-control spending programs.
There is nothing new, surprising, or shocking about the $1 trillion coin proposal. It is perfectly in tune with the zeitgeist and with established trends in politics.
Bernanke will need a new script
So, what is significant about it? – Only one thing in my view: It exposes Bernanke as a liar.
Remember that Bernanke, and also his other central bank chums, such as Mervyn King and Mario Draghi, have tried to maintain the myth that they could one day – if markets allowed it or required it – reduce their bloated balance sheets. During the financial crisis, the Fed has ballooned its balance sheet from $800 billion to close to $3 trillion. We are supposed to believe that this is all temporary. Just to provide a stimulus. Nobody calls this debt monetization or ‘funding the government’. Same in Europe: Mervyn calls it ‘unlocking the credit markets’, Mario calls it ‘making sure the monetary transmission mechanism works’. The idea is that when the economy is finally mended the central banks can ‘normalize’ their balance sheets. More importantly, should inflation concerns arise, the central banks would quickly mop up all the excess bank reserves that they provided through ‘quantitative easing’ and sell the very assets they accumulated during the easing cycle. That would mean liquidating the central bank’s holdings of – among other things – government bonds.
But once the government has replaced liquid government bonds on the central bank’s balance sheet with illiquid coins the central bank’s maneuverability is severely restricted. When the public gets nervous about inflation, the central bank would have to reverse its crisis-policies and sell assets. There is (still) a market for US Treasury debt. However, there is no market for $1 trillion coins.
While the central bankers try to convince the public that their buying of government debt is a special case, an exception, a temporary policy measure, and that they could still defend the value of paper money if circumstances require, the politicians have other plans. They already consider central bank buying a permanent source of funding – unlimited and ever-lasting. I have long maintained that the central banks have no ‘exit strategy’, that they will simply not be allowed to reverse course. This is now becoming part of the official narrative, and central bankers who maintain otherwise are either hopelessly deluded or simply lying.
The deficits are here to stay and they will be funded by the printing press. No limit, no end, no exit.
Will this lead to inflation? _ Well, unless you are a fully signed-up member of the Church of Modern Monetary Theory, you know the answer.
Episode 73: GoldMoney’s Andy Duncan talks to Godfrey Bloom, who represents Yorkshire and North Lincolnshire in the European Parliament, and who is a member of the parliament’s Committee on Economic and Monetary Affairs. They talk about the possibility of Germany instituting a gold-backed Deutschmark, and broader issues to do with European monetary and fiscal policy.
In a recent Mises.org daily article co-authored with Patrick Barron, Mr Bloom states that Germany now has a “Golden Opportunity” to get back to sound money by pulling out of the euro and introducing a gold-backed Deutschmark. However, given the lack of a comprehensive audit, suspicions about the integrity of the German gold reserves remain. Bloom therefore advocates that Germany should repatriate its physical gold from the storage locations abroad.
They also talk about monetary policies of the European Union, the errors of European politicians and whether or not the eurozone can be sustained. In addition, they also discuss Britain’s relationship with the EU and Britain’s own precarious financial position, particularly in relation to its welfare state and deficit spending.
This podcast was recorded on 21 November 2012 and previously published at GoldMoney.com.
It might seem like yesterday to some but it was already in 2009 that politicians in Europe began to talk about ‘austerity’, a concept that quickly became the new black in European political fashion. In brief, austerity in Europe is based on the idea that the accumulated sovereign debts are now dangerously large and need to be reduced by some combination of temporary (so they claim) tax increases and spending cuts. Once the debt is reduced to a more manageable level, so the thinking goes, taxes can be cut and spending restored to the previous level.
Sounds oh-so reasonable now, doesn’t it? The problem is, however, it isn’t working. As we approach the end of 2012, in every instance of austerity being applied, economic growth is weaker and government deficits higher than projected, the result being that the accumulated debt burdens continue to grow. Indeed, they are growing more rapidly than prior to the onset of austerity!
Now one key reason for this is that, concerned about the dire state of the economies in question, the financial markets have dramatically driven up their governments’ borrowing costs. Private sector investors seem unwilling to underwrite the risk that austerity might not work. To a small extent, the European Central Bank (ECB) has stepped in to fill the funding gap, purchasing selective clips of bonds from distressed euro-area governments, but this provides only temporary support.
The simple math of the matter is that unless borrowing costs fall substantially, austerity will fail. But how to bring down borrowing costs when private investors are not convinced austerity is going to work? Why, have the ECB take a much larger role. Hence the showdown between the German Bundesbank, opposed to open-ended bank and sovereign bail-outs, and, well, just about every euro-area politician, policy maker and Eurocrat involved. Let’s briefly explore this important tangent.
AUFTRITT DER UNBEUGSAME WEIDMANN
(ENTER THE UNYIELDING WEIDMANN)
To outside observers, this situation may seem rather odd. Following the introduction of the euro, the Bundesbank ceded power over German monetary policy and, by extension of the German mark’s previous role as anchor currency, over euro-area monetary policy as well. (The Bundesbank retains an important regulatory and supervisory role with respect to German financial institutions.) So how is it, exactly, that the Bundesbank is somehow in a position to resist what has now become a near universal euro-area march toward some form of debt monetisation?
Well, as it happens, the German public hold the Bundesbank in rather high regard. Most Germans recall how the Bundesbank long presided over Europe’s largest economy, maintaining price stability and fostering a sustained relative economic outperformance. Many Germans probably recall how, on multiple occasions, the Bundesbank successfully resisted inflationary government policy initiatives. Older Germans recall how the Bundesbank contributed to the Wirtschaftswunder (economic miracle) of the 1950s and 1960s. And Germans know that the ECB was supposedly modelled on the Bundesbank and the euro on the German mark.
So when the Bundesbank speaks, Germans listen. And when the Bundesbank voices concern over ECB or German government policy, Germans become concerned. And so it is today. It has been widely reported in the German press that Bundesbank President Jens Weidmann has threatened to resign at least once in protest over potential German government participation in inflationary bail outs of distressed euro-area banks and governments. Apparently Chancellor Merkel has pleaded for Weidmann to remain at the helm and so far she has succeeded. 
But what if she should fail? What if Weidmann does indeed resign in protest at some point? His former colleagues Axel Weber and Juergen Stark have already done so (In Stark’s case, from the ECB, not the Bundesbank). What if some of his Bundesbank board colleagues join him?
I can’t emphasise this point enough: The institution of the Bundesbank is held in such high regard among the German public that should Weidmann and any portion of his colleagues resign in formal protest of bailouts in whatever form, it may well bring down the German government, throw any bailout arrangement into complete chaos, spark a huge rout in distressed euro-area sovereign and bank debt and quite possibly result in a partial or even complete breakup of the euro-area. The Bundesbank thus represents the normally unseen foundation on which the entire euro project rests. Should it remove its support, it may all come crashing down.
But why would the Bundesbank ever do such a thing? Isn’t it just a bureaucracy like any other, expected to serve the government? Well, no. Consider the unique role of the Bundesbank under German Law. It is not answerable to the government. It is its own regulator. Its board members are appointed by the president—the head of state—not the chancellor, the head of the government. Its employees are sworn to secrecy during both their active service and in retirement. The Bundesbank alone determines whether its employees have infringed its code of conduct and determines what disciplinary actions, if any, should be taken.
Weidmann’s intransigence is thus entirely in line with German law and tradition. The Bundesbank, by design, will confront the government if it believes that such action is necessary to carry out its mandate. And what is that mandate? As per the original Bundesbank Act, “The preservation of the value of German currency.” Previously the mark, the euro is now the German currency and the Bundesbank’s mandate is to preserve its value. Needless to say, open-ended bailouts of euro-area banks and sovereign countries would, without question, threaten that value.
You can be certain that when President Weidmann said earlier this year that what was being proposed by the ECB “violated its mandate,” he chose his words very, very carefully. In a subsequent speech on the same topic, he quoted from Goethe’s Faust, arguably the most famous play in German literature and a classic warning against hubris and temptation. You don’t do that if you are not deadly serious. The implication, no doubt, is that Weidmann is sending a message that the Bundesbank is independent of the ECB with respect to determining whether or not ECB policies are consistent with “the preservation of the value of German currency,” which now happens to be the euro. The Bundesbank has thus re-assumed this dormant but ultimate power over German monetary policy. Under just what circumstances it will choose to exercise it, I don’t know, but if the German and other euro-area governments continue along the road to bailouts, it will almost certainly happen at some point, presenting the greatest challenge yet to the sustainability of EMU in its current form.
WHY ‘AUSTERITY’ DOESN’T WORK
As mentioned earlier, austerity isn’t working, in many countries largely because borrowing costs are not declining. But if austerity were credible, they would. What is it about austerity as implemented that is failing to win over bond investors?
I have some ideas. First, note that, so far at least, austerity in practice is more about tax increases than spending cuts. However, the countries in question are already among the most highly taxed in the world. As Arthur Laffer and others have suggested in theory and has often been observed in practice, beyond a certain point, tax increases not only fail to generate additional revenue but actually reduce it. (It so happens that the Scandinavian debt crisis of the early 1990s was addressed not with tax increases but with tax cuts, as well as spending cuts. Rapid growth followed, although for a variety of reasons including substantial currency devaluation.)
Second, consider that the countries in question have enormous accumulated debt burdens, in some cases previously disguised and underreported. Cooking the books does not instill investor confidence. Yet paying down such a large debt mountain is going to take a long, long time. Today’s investors need to trust not only today’s politicians, but their successors down the road, to make good on promises that will remain subject to political opportunism and expedience for many years.
Third, governments may talk a good game but can they walk the walk? A close look at European ‘austerity’ legislation reveals that actual spending cuts are few and far between. What is being proposed in most cases is that the rate of spending increases declines. But an increase is still an increase and absent healthy economic growth needs to be financed with, you guessed it, more debt. Investors may want to see real rather than ‘faux’ austerity before accepting lower debt yields.
Fourth, let’s consider the possibility that what investors are really interested in is not some accounting plan that looks nice on paper, assuming governments can rein in runaway spending, but rather a more comprehensive plan that fundamentally reforms economies, making them more flexible and competitive. If growth is not to be provided by deficit spending—the traditional welfare state model—it must be provided by an unsubsidised private sector. If an economy lacks capital or skilled workers, or taxes either labour or capital at too high a rate, it is not going to be able to grow and pay down debt. Such fundamental reform remains essentially off the table in the austerity plans discussed to date.
Finally, let’s turn to a technical but extremely important point, namely, how austerity as observed in practice adds further evidence to the already substantial pile demonstrating that the dominant neo-Keynesian paradigm held by the economic policy mainstream is itself deeply flawed.
INCONVENIENT MULTIPLIER MATHS
The difficulties with austerity go beyond merely placating the bond markets. The fact is, a large debt burden is a huge economic problem. Sure it is preferable to be able to finance the debt at low rates, but if you want to pay it down you must divert resources from elsewhere. That is going to be painful at any interest rate. But such are the political pressures on the modern welfare state that the accumulation of an excessive, unserviceable debt over time is a near certainty.
Why should this be so? Well, back in the days before the modern welfare, or ‘nanny’ state, politicians didn’t pretend to have solutions for everything. If you were overweight, it was your problem. If your kids didn’t learn basic reading, writing and numeracy, at home or at school, it was their problem. With the growth of the welfare state, however, more of your problems become politicians’ problems and, by extension, those of the taxpayers who must provide the funds for the ‘solutions’.
As the tax burden grows over time, however, taxpayers gradually begin to resist tax increases. In practice, this has resulted in the welfare states steadily accumulating debt, as taxpayers have repeatedly refused to pay the high rates of tax up front to finance the welfare policies in question.
In many welfare states, the average taxpayer is a major receiver of benefits, including publicly provided heathcare and education. Taxpayers in welfare states are suffering a collective ‘tragedy of the commons’, in which each tries to extract maximum benefit for minimum cost. The result is a steadily accumulating debt, representing that portion of welfare not covered by current tax revenues.
The dangers of an accumulating debt can be disguised, however, as long as economic growth appears healthy enough to service the debt. This is where the so-called ‘multiplier’ comes in. As the debt grows, it adds to GDP growth via the multiplier effect: for each unit of deficit spending, the economy will in fact grow by some multiple of that. (This is because deficit spending creates money through borrowing that would not otherwise have been created and this new money flows out into the economy where it stimulates growth generally). This process can go on for many years, as we have seen.
The neo-Keynesian economic mainstream doesn’t see anything wrong with this in principle, as long as debts don’t become excessive relative to GDP. But welfare politics being what they are, they do. (It is a rare welfare state indeed that can rein itself in as debts swell. Indeed, the exceptions that prove the rule here are few and far between and are explained primarily by natural economic advantages.) When a welfare state finally reaches the limits of debt accumulation, as the bond markets refuse to finance any further increase in debt at serviceable rates, some form of austerity would seem to be required.
No so fast. In its most recent World Economic Outlook, the International Monetary Fund (IMF) surveys the evidence of austerity in practice and does not like what it finds. In particularly, the IMF notes that the multiplier associated with fiscal tightening seems to be rather larger than they had previously assumed. That is, for each unit of fiscal tightening, there is a greater economic contraction than anticipated. This results in a larger shrinkage of the economy and has the unfortunate result of pushing up the government debt/GDP ratio, the exact opposite of what was expected and desired.
While the IMF might not prefer to use the term, what I have just described above is a ‘debt trap’. Beyond a certain point an economy has simply accumulated more debt than it can pay back without resort to currency devaluation. (In the event that a country has borrowed in a foreign currency, even devaluation won’t work and some form of restructuring or default will be required to liquidate the debt.)
The IMF is thus tacitly admitting that those economies in the euro-area struggling, and so far failing, to implement austerity are in debt traps. Austerity, as previously recommended by the IMF, is just not going to work. The question that naturally follows is, what will work?
Well, the IMF isn’t exactly sure. The paper does not draw such conclusions. But no matter. If austerity doesn’t work because the negative fiscal multiplier is larger than previously assumed, well then for now, just ease off austerity while policymakers consider other options. In other words, buy time. Kick the can. And hope that the bond markets don’t notice.
Speaking of not noticing, one could be forgiven for wondering whether this IMF paper was not in fact written with precisely this agenda, that is, to provide an expedient justification for easing off the austerity brakes for awhile. Why? Well as it happens, the IMF’s analysis is not particularly robust. First, they use a data set with a rather short history. Second, their claim to have generated robust statistical results seems questionable. How so? Well, have a look at the following chart:
Now the slope of the line through the data is meant to show the forecast error based on the old multiplier assumptions, in other words, the extent to which the IMF has got things wrong. Note Greece in the lower right corner, representing the unanticipated negative effects of a rather extreme fiscal tightening, and Germany in the upper left, representing the forecast error associated with a moderate fiscal expansion. But if you eliminate these two extreme observations from the sample—something any good statistician would do as a reality check—guess what? You are left with a statistically insignificant ‘blot’ of observations from which you can’t really conclude anything. In other words, the IMF is jumping to conclusions. Now why might that be?
I have an idea. Consider: some of the more outspoken Keynesians wasted no time touting these findings as ‘proof’ that austerity can’t work; that what is really needed is more stimulus, not less; that their arch-Keynesian views have now been vindicated!
Among this group are Paul Krugman, who never saw a stimulus he didn’t like; and former Fed economist Richard Koo of Nomura, who shows a bit more discretion in his views. But in this case they are on the same page: the IMF data are clear, unambiguous evidence, in their view, that the problems created by excessive debt are best addressed with more debt, rather than less. Logic, apparently, is mere inconvenience for those with a PhD in Keynesian economics, as are questionable, cursory statistical analyses, normally referred to pejoratively as ‘data-mining’.
MULTIPLIER REALITY CHECK
Now that we have seen how two prominent Keynesians have responded with applause to an unabashedly Keynesian-inspired IMF study, let’s step back and consider the broader implications for a moment. As is the case with many policy papers, this one is perhaps more notable for what it doesn’t say than for what it does.
Consider: even if the IMF paper is correct in its questionable statistical observations, why, exactly, might the multiplier be larger on the downside than on the upside? Could it be that the net economic benefits of borrowing and consuming through the years are more than outweighed by the eventual requirement that the accumulated debts are paid down? Could it be that borrowing and consuming your way to prosperity doesn’t actually work? Or, conversely, that good, old-fashioned saving and investing your way to prosperity does?
The IMF does not ask and thus does not even begin to answer these common-sense questions. If it did, it might come to some rather common-sense conclusions. That they just perform a data-mining exercise, apparently to serve an agenda, rather than ask and answer the real questions, is yet more evidence that the dominant neo-Keynesian paradigm is being exploited by self-serving policymakers seeking any excuse they need to keep borrowing, spending and consuming, so that the inevitable, unavoidable hard choices need not be made on their watch. Leave it rather to their successors or, better yet, the next generation, or the generation after. After all, isn’t it just human nature for parents and grandparents to expect their children and grandchildren to take care of them in their old, infirm age? In any case, it takes hard work and some sacrifice to actually provide for the next generation to have a higher standard of living. But hey, we’re rich enough as it is, aren’t we? Isn’t poverty a thing of the past? And don’t we aspire to higher things these days like economic equality, political correctness, or ‘nanny’ rules and regulations to keep us from smoking, or drinking, or gambling, or whatever other immoral, reprehensible, irresponsible behaviours? Worrying about debts and budgets is just so passé!
Well, ask the Greeks or the Spanish how they feel about political correctness these days. Or ‘nannystate’ rules on personal behaviour. Something tells me they might be rather more concerned with putting food on the table. And something tells me that the theoretical future of the welfare state, long predicted by von Hayek, von Mises, Friedman, Buchanan and other notable, non-Keynesian economists, is rapidly colliding with the actual present, in a list of countries that continues to grow.
Before we move to the next topic, some readers might be asking themselves, if neither ‘austerity’ nor stimulus is the answer, what on earth is? My answer to this question is that the ‘faux austerity’ I mentioned earlier isn’t really austerity at all. Tightening the screws on a failing welfare state without fundamental reform is not going to convince investors to hold additional debt. Corporations that are fundamentally uneconomic need to do more than cut a few costs here and there if they want to rollover their debts. They need to engage in some ‘creative destruction’ of their operations. Anything less, and bond investors will walk away and leave them to their fate.
Unfortunately, the political processes of the modern welfare state, entrenched as they are in administering entitlements of various kinds, do not lend themselves to fundamental economic reform. Thatcher’s near-bankrupt Britain is a rare exception, in which a highly charismatic politician, against all political odds, took a principled stance against the relentless growth of the welfare state and managed to slow its growth for a time. She didn’t stop it, however, something that the present British government, soon to face near-bankruptcy yet again, no doubt regrets.
While Keynesians prefer to ignore relevant examples, the fact is, real austerity is possible. Look at the Baltic States of Estonia, Latvia and Lithuania. Look at Bulgaria, or Slovakia, or Iceland. Look at South Korea, Thailand, Malaysia and other Asian countries hit hard by their collective debt crisis in the late 1990s. It can be done. But it implies real economic hardship for a period of time and it goes right to the heart of the government, which must shrink relative to the private sector. Many career politicians and bureaucrats will simply find that they are out of work and that they must seek private sector jobs, without guaranteed state pensions and other benefits, like most ordinary folks.
THE IMF RESURRECTS THE ‘CHICAGO PLAN’
The reality of contemporary welfare state politics being what it is, I would argue that there is essentially zero chance that the Keynesians in charge are going to do an about-face. Sure, they might have realised that their policies are not working, but this just means that they are going to raise the stakes. As some are now beginning to argue, there is in fact no reason to worry. Austerity might not work once you are stuck in a debt trap, but so what? What if you could just wave a magic wand and make the debt disappear? Now that would solve all our problems, wouldn’t it?
We know intuitively that this is nonsense. But just because something is nonsense doesn’t stop policymakers from spouting it when expedient. As I wrote in an Amphora Report back in 2010, as the euro-area debt crisis was escalating:
Just as there is no free lunch in economics generally, there is no magic wand in economic policy. Policymakers who claim otherwise are like magicians distracting their audience. As is the case in the physical world, in which there is conservation of energy–the first law of thermodynamics–there is also conservation of economic risk. It cannot be eliminated by waving a magic wand. It can, however, be transformed from one type of risk to another.
As it happens, such sleight-of-hand risk transfer forms the core of the sophistic argument put forth in a superficially scholarly paper published recently by the IMF. The authors, Jaromir Benes and Michael Kumhof, resurrect the long-forgotten ‘Chicago Plan’ of the 1930s, first proposed by Irving Fisher, an early exponent of the Monetarist economic school associated with the University of Chicago. In brief, the Chicago Plan proposes changing the nature of money and money creation in the economy from a nominally private-sector affair, in which commercial banks serve as the engines of money growth, to an exclusively public sector one. Somehow, replacing private sector assets and liabilities with public sector ones is supposed to reduce or eliminate the various problems associated with the current system, in which money creation is supposedly a ‘private’ affair.
While I could have a go at pointing out in detail just how hideously flawed this paper is, fortunately I don’t need to. My friend and fellow financial writer Detlev Schlichter recently penned a devastating critique and I highly recommend reading it in its entirety. For our purposes here, a few particularly relevant quotes follow:
[T]he paper sets up an entirely new and I believe bogus problem based on the premise that in our monetary system money is supposedly provided ‘privately’, that is, by ‘private’ banks, and ‘state-issued’ money only plays a minor role. From this rather confused observation, the paper derives its key allegation that ‘state-issued money’ ensures stability, while ‘privately-issued money’ leads to instability. This claim is not supported by economic theory… Monetary theory does not distinguish between ‘state-controlled money’ and ‘privately produced’ money, it is a nonsensical distinction for any monetary theorist. An attempt to give credence to this distinction and its alleged importance is made in a later chapter in the Benes/Kumhof paper but, tellingly, this attempt is not based on monetary theory but on an ambitious, if not to say bizarre, re-writing of the historical record.
Detlev then goes on to point out precisely why this ‘public’ vs ‘private’ money distinction is all but meaningless not only in theory but in practice:
In recent decades, the global banking system found itself on numerous occasions in a position in which it felt that it had taken on too much financial risk and that a deleveraging and a shrinking of its balance sheet was advisable. I would suggest that this was the case in 1987, 1992/3, 1998, 2001/2, and certainly 2007/8. Yet, on each of these occasions, the broader economic fallout from such a de-risking strategy was deemed unwanted or even unacceptable for political reasons, and the central banks offered ample new bank reserves at very low cost in order to discourage money contraction and encourage further money expansion, i.e. additional fractional-reserve banking. It is any wonder that banks continued to produce vast amounts of deposit money – profitably, of course? Can the result really be blamed on ‘private’ initiative?
To answer Detlev’s rhetorical question: of course not! Just because commercial banks are legally private entities does not in any way imply that they are not de facto agencies of the government. Fannie Mae and Freddie Mac were private sector entities too, prior to being placed into official government ‘conservatorship’, albeit ones engaged in even narrower, more heavily regulated activities than ordinary commercial banks.
Perhaps the best way to think about how banking institutions have operated in recent decades is as private utility companies, with their activities heavily regulated and subsidised by the central bank and a handful of government agencies. Or, to use another industry as an example, consider defence contractors. Sure, they might be private firms in the legal sense, but the business in which they are engaged—defence—is so intertwined with the activities of government that it is essentially impossible to distinguish just where the public role ends and the private role begins.
No doubt the legal grey area that exists between public and private activities in any industry is fertile ground for corruption and abuse. In finance, however, this grey area reaches right into the heart of the money and credit creation process and, thereby, has an insidious if largely unseen impact on the entire economy. To blame ‘private sector’ money and credit growth for the mess we are in, as Messrs Benes and Kumhof do in their paper, demonstrates either colossal ignorance or disingenuousness. I leave it to the reader to decide which.
MONETISATION BY ANY OTHER NAME
If while reading the above you thought that what in effect is being proposed is a massive monetisation of debt, you are right. That is exactly what it is. All but the most radical of Keynesian economists, however, refrain from using the ‘m’ word. They prefer wonkish terms like ‘quantitative easing’ for example. Or, when there is natural downward pressure on prices, they say extreme measures are called for due to ‘inflation targeting’. When they get really desperate, they do occasionally refer to things like the ‘printing press’ or even ‘helicopters’, but somehow the ‘m’ word is something only ever contemplated by two-bit dictators, be they fascist, communist or some combination of the two. After all, monetisation is blatant, in-your-face wealth confiscation from private sector savers to public and financial sector borrowers. Modern, enlightened welfare state democracies would never contemplate such a thing now, would they?
Perhaps this is one reason why the German Weimar hyperinflation is regarded with such horror in the modern economics profession, even though it is but one of many fiat money hyperinflations of the past century. How could a reasonably free and open democracy—indeed, the one in which the idea for the modern welfare state originated—possibly resort to monetisation to solve its excessive debt problem, a legacy of WWI? How irresponsible! Had they just done as Krugman, Koo or other modern Keynesians recommend, and stuck to QE and double-digit fiscal deficits, why, they would have been just fine!
Yes, I’m being faceitious yet again. But come on folks, the idea that somehow, by calling ‘monetisation’ something else makes it so, is just another example of the intellectual sophistry being practiced at the IMF and elsewhere in Keynesian policy circles. They are playing a semantics game while trying desperately to get governments the world over to get on with outright debt monetisation, assuming that this would never morph into a hyperinflation or other such economic calamity.
Ah, but it might. Sorry to sound alarmist, but at some point it might. Reality is a harsh mistress. The future has a way of arriving now and again, sometimes when you least expect it. Responsible folks need to take a sober look at the road we are on. Ignore the can being kicked along the road and focus instead on where the road leads. In this case, it leads to some combination of currency debasement, devaluation and debt default (with the latter substantially less likely, in my opinion, although I would not rule it out in certain cases). It might, just might, lead to a hyperinflation.
So what is a defensive investor, interested primarily in wealth preservation, to do? My advice in this matter has changed little since the first Amphora Report went out in early 2010. Diversify out of financial and into real assets that cannot be debased, devalued or defaulted on. Within financial assets, overweight income-generating stocks in industries with pricing power, that is, those more easily able to pass cost increases through to consumers. Within real assets, acquire some physical, allocated gold and silver but note that these are already trading somewhat expensive relative to most other commodities.
One important lesson of the Great Depression and other periods of severe economic deleveraging is that the prices of less fashionable commodities such as agricultural products can become extremely depressed from time to time and that they tend to outperform precious metals once they cheapen (in relative terms) to a certain point. I would argue that we are at or near that point already.
The Amphora mantra has always been and remains to diversify. Diversification is the only ‘free-lunch’ in economics, frequent Keynesian claims to the contrary notwithstanding, and it is the best form of financial insurance there is. Better than gold. Better than silver, or any single commodity. Better than any one stock, or stock market for that matter. Better than any one bond market, or any one currency. In a world of not just known unknowns, but even unknown unknowns, it would be imprudent to place any number of eggs in just one basket. Even golden ones.
 ECB President Mario Draghi affirmed this policy at today’s monthly ECB press conference and also suggested strongly that the ECB is likely to purchase substantially more debt in future.
 Among other German publications, Der Spiegel reported on this. The link to the article is here.
 Weidmann’s specific words, in German, for those interested, were the following: “Die Bundesbank steht hinter dem Euro. Und gerade deshalb setzen wir uns mit Verve dafür ein, dass der Euro eine stabile Währung bleibt und die Währungsunion eine Stabilitätsunion. Es gibt verschiedene Wege, dieses Ziel zu erreichen. Sicherlich nicht erreichen werden wir dieses Ziel aber, wenn die europäische Geldpolitik in zunehmendem Maße für Zwecke eingespannt wird, die ihrem Mandat nicht entsprechen. The link to this speech is here. His reference in a subsequent speech to Goethe’s Faust can be found at the link here.
 Those welfare states with manageable debt burdens tend to be endowed with plentiful natural resources, such as Norway, Sweden Finland, or Canada, for example. This makes them natural exporters and enables them to finance a certain degree of domestic welfare without resorting to chronic debt accumulation.
 The IMF World Economic Outlook can be found here.
 For more on the concept of a ‘debt trap’, please see “Caught in a Debt Trap”, Amphora Report vol 3 (July 2012). The link is here.
 I have written at length about the critical yet commonly overlooked role that Schumpeterian ‘creative destruction’ plays in a healthy economy. For a recent example, please see “Why Banktuptcy is the New Black,” Amphora Report vol. 3 (April 2012). The link is here.
 “There May Be No Free Lunch, but Is There a Magic Wand?” Amphora Report vol. 1 (September 2010). The link is here.
 The entire paper, The Chicago Plan Revisited, can be found on the IMF’s website here.
 Detlev’s paper is posted to his blog, linked here. I also highly recommend Detlev’s book, Paper Money Collapse, details of which you can also find on his blog.
 For those curious, German chancellor Bismarck introduced the first European pay-as-you-go state pension in the 19th century. It has served as the original model for state pensions subsequently introduced in most of Europe and North America. Germany was also an early adopter of compulsory public education.
 You can find the inaugural Amphora Report here.
Currently serving as the Chief Investment Officer of a commodities
fund, John was previously Managing Director and Head of the Index Strategies Group at Deutsche Bank in London, where he was responsible for the development and marketing of proprietary, systematic quantitative strategies for global interest rate markets.
A cum laude graduate of Occidental College in California, John holds a Masters Degree in International Finance and Economics from the Fletcher School of Law and Diplomacy, associated with Harvard and Tufts Universities.
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13 November 12 | Tags: Bundesbank, Chicago Plan, ECB, Euro, Hyperinflation, Inflation, Irving Fisher, Keynesianism, Laffer Curve, Richard Koo, Sovereign Debt | Category: Economics | One comment
Conveniently coming just in time for the crucial Party conference, the official China PMI index inched above the 50-level watershed and so was enough to gladden the heart of loyal cadres and sell-side analysts everywhere. Truly now the bottom is in place and we can return to unbroken months of expanding economic activity under the wise guidance of the new leaders, all the while looking forward to inexorably higher asset prices across the globe!
Well, perhaps. But, is it really sensible to suppose that the weight of evidence offered by this one, single datum is enough to tip the scale of judgement, or would it be better to seek for confirmation elsewhere – not least in the next instalment of said series, given that it is not seasonally adjusted and so is subject to the vagaries of the Chinese lunar holiday calendar?
Certainly, we might be allowed to nurse our scepticism a little longer, if only because one of the main economic sectors contributing to this uptick was the otherwise badly bruised steel industry. Having increased production by a bare 1.7% in the first nine months over the like period in 2011, October’s more favourable constellation of input prices has combined with a long-overdue reduction of inventories to spur the country’s mills to encompass a PMI-boosting, 8% jump in the daily rate of output when compared to late September.
All well and good, but recall this is an industry in which profits of the so-called ‘above-scale’ firms fell 68% YOY, while the listed steel companies actually made an aggregate net loss. Even the mighty Baosteel has been suffering; printing a ‘profit’ partly by dint of asset dispositions – and, even then, returning less on capital than would one of China’s notoriously unremunerative bank deposits. Incidentally, we put the quotation marks around the ‘profit’ to highlight the fact that the explosion in the firm’s accounts receivable has amounted to almost four-fifths of reported operating income over the last six months.
Rationalization, in a business with fast approaching 900mt of capacity servicing no more than 680mt of domestic demand, has proved elusive, largely because of the usual curse of local government politics. Not only are steel companies major local employers, but they pay taxes based on output, not profit, greatly increasing the perverse incentives to which their management is subject.
Adding a certain frisson to the situation is a Bernstein Research report into steel trader fraud. Here, with echoes of the Great Salad Oil Swindle perpetrated by Tino de Angelis exactly fifty years ago, it appears that a number of firms have not only been pledging the same steel as collateral several times over, but that some of the alloy so committed consisted of nothing more than a surface layer of steel laid on top of a pile of near-valueless sand. As a result of this discovery, it is said that Guangzhou traders are now only making good on half their orders, rather than on the already recession-shrunken 70% characteristic of the previous three months, raising the question of just who will buy the new product pouring out of the mills.
Though there are the inevitable murmurings of better things to come as the government launches yet more, white elephant, infrastructure projects, those pinning their hopes on a sustainable upswing manifesting itself in the near future would do well to listen to what Ma Guoqiang, Baosteel’s general manager recently said in an online briefing.
Judging from current global and domestic economic growth, it is realistic to expect the ‘cold winter season’ to last for three to five years, and the steel sector will not be an exception.
Some heed of this ill wind seems to have been taken by the big miners, notably BHP Billiton, which has radically restyled its corporate message in recent months to the point that the most prominent slogan in its latest presentational material was that its “focus has shifted from the marginal tonne to the capital efficient tonne.”
A far cry, indeed, from last year’s defiant emphasis on the super-cycle; on ever mounting, Chinese per capita usage; and on the heady plans for the $80 billion in new capex need to surf this envisaged wave.
Highlighting the contrast, Chief Executive Marius Kloppers – fresh from cancelling no less than $68 billion of those projected expenditures – struck a much more sombre note last month, telling his audience that:-
Miners have responded to unsustainably high prices for some commodities such as iron ore and metallurgical coal over the past decade by building new production capacity. Over that period, robust demand growth from China and other developing nations outstripped production growth as the industry grappled with escalating mining costs and strengthening currencies in commodity producing countries…
But the industry has improved its ability to meet incremental demand with low cost supply and commodities demand growth from emerging economies, particularly in China, is forecast to moderate as developing economies transition to consumption-led growth from infrastructure-led growth…
…what we are now witnessing is the rebalancing of supply and demand and a progressive recalibration of prices back to long term sustainable pricing levels. In effect, what this means is that the record prices we experienced over the past decade, driven by the ‘demand shock’, will not be there to support returns over the next 10 years. What we can instead expect is demand growth at more predictable and sustainable levels and more moderated pricing. This ‘mean reversion’ in prices and returns is something we at BHP Billiton have anticipated for some time…
…The physical iron ore demand of China will go down. That high end of the cost curve will disappear. Still a very good business but not the massive EBIT margins we have today… a very significantly less amount of revenue…
It may well be, of course, that Mr. Kloppers will prove no more prescient regarding the genesis of this tough, new reality than he was in foretelling the demise of the old, Klondike era but it would seem foolhardy not to assume that the head of one of the largest and most successful integrated mining companies might be able to give us some pointers as to conditions on (or may be, under) the ground.
Elsewhere in Asia, PMI’s were mixed in terms of month-on-month changes, but were almost universally mired on the contractionary side of the ledger – though you would never have guessed this to be the case, given the positive glow elicited by the one or two less gloomy releases seen in the region of late. We would only reiterate that the place still suffers from a widespread reliance on exports to a faltering Europe as well as to a still-tepid America. Together with the complex entanglement which much of the Orient has woven with a China still wrestling with the superposition of a Gosplan-like growth directive and layers of rampant nest-feathering on top of a very Austrian credit bust, this strongly implies that it will take more than a brief – and possibly random – interruption of the downwave to instil any confidence that the worst truly is behind us. Just ask Panasonic, HTC, Dongyang, or Sharp.
Adding to the suspicion that things are not exactly steaming full ahead, the first intimations of October’s banking figures from China suggest that an almost complete reversal of the prior month’s large deposit increase was suffered by the Big 4, while, on the other side of the balance sheet, lending was very weak right up to the last three days of the month when an extraordinary CNY100 billion late burst saved the day. Word is that much of this took the form of corporate credit – but how much of that represents distressed borrowing, only time will tell.
Amid press comments to the effect that SME loan demand was weak (not surprising perhaps, given the lacklustre showing at the autumn instalment of the Canton Fair), that lending was ‘about complete’for the year, and that even local infrastructure finance was largely being limited to roll-overs and to ensuring completion of existing projects, matters seem a deal less settled than the permabulls would have us believe.
And let us be in no doubt just how pivotal Chinese banks are to the whole, top-heavy, output-driven, malinvested superstructure. In the year through end-September, just sixteen of them were responsible for no less than 54% of the entire sum of aggregate profits posted by the country’s 2,493 listed companies – even if they could only manage this unhealthy predominance by the determined misrepresentation of their bad loan levels. After they had extracted their bounteous harvest of rents, the nation’s commercial and industrial rump of 2,477 firms saw their revenues inch up by less than 5%, their pre-receivable ‘profits’ fall 18%, and their already exiguous operating margins slump 22% to a mere 4.3 cents on the dollar.
Nor was there much cheer to be had from Li Zibin, president of the China Association of Small and Medium Enterprises, who announced that his members were facing more difficulties this year than they did in 2008. Citing the slowdown both home and abroad, Li said that rising labour costs, pricier raw materials, fund-raising difficulties, and the appreciation of the RMB were among the private sector’s litany of woes.
Then again, a certain degree of caution is only to be expected when we take into account the ongoing rumours that the imminent leadership handover is still the subject of internecine strife between the factions. Not only has former leader, éminence grise – and ‘conservative’ hard-liner – Jiang Zemin been unusually prominent of late but reformists Zhu Rongji and Li Ruihuan have also resurfaced from self-imposed obscurity to root for the opposing team, if to little obvious effect if we believe the spin the SCMP has put on events.
Tellingly, the PLA Daily issued a forthright declaration of its loyalty to the Party and Chairman Hu, warning of the need to guard against the existence of “hostile forces in and outside China… ready to make trouble.” Note the ominous use of the first of those two positional prepositions.
Faced with what could be the appearance of the most tenebrous of cygneous waterfowl in Economy No.2, the results of the upcoming vote in Economy No.1 might seem to offer far less chance of triggering a decisive shift. After all, the cynic would see the difference between the candidates as one more of degree than of kind, especially if he were to limit his concern to the policies the two candidates will actually get around to enacting, rather than those whose superficial distinctions have been grossly exaggerated at the hustings.
As the inimitable H. L. Mencken long ago phrased it:
Each party steals so many articles of faith from the other, and the candidates spend so much time making each other’s speeches, that by the time election day is past there is nothing much to do save turn the sitting rascals out and let a new gang in.
Yes, there is a chance that, freed from the personal need to secure further re-election, Obama might become more radical in his final term – and thus enact a greater programme of tax-and-spend, as well as giving rein to a more undiluted brand of eco-alarmism and green energy boondoggling. Little of that strikes your author as at all helpful to the chances of a meaningful American renaissance.
Against this, Romney promises to be more business-friendly – though one has to doubt whether his proposed menu of tax cuts will really be offset as it should by a like, much less by a desirably greater, reduction in outlays. One unalloyed plus is that he purports to offer far less in the way of impediments to further entrepreneurial success in securing the development of America’s rich mineral legacy. In contrast, his rather crude, eschatological take on foreign policy could prove horribly disruptive to us all if he surrenders control over his country’s might to the implicit furtherance of another, far less heedful country’s warlike agenda.
Whoever wins, we are sure to wake up on Wednesday morning with the Bernanke Fed continuing to wreak havoc by destroying the pricing ability of capital markets; with Federal debt growing at the rate of $40,000 a second – not all that far shy of what a typical family earns in a year – with a debilitating dependency on the state all too elevated, and with any number of restraints to peace and progress not only unresolved, but utterly unresolvable under present conditions and under the leadership of two such solidly mainstream candidates.
It’s not as if we’re going to give Ron Paul a chance to fix things, now is it?
Already, real net private product per capita has been stagnant for more than a decade, mirroring its poor showing during the inflationary disaster of forty years ago. Even if Romney and Ryan were to win and Bernanke were then to tender his resignation to two men who have openly disparaged him during the campaign, the latter’s replacement would be both outnumbered by a dovish FOMC and a prisoner of the initial conditions from which he must start. To expect a radical turnaround under such conditions would be to display as much naivety about the prospects for ‘change’ as did the incumbent’s worldwide fan club of bien pensants four short years ago.
In Europe, the Greeks and Spaniards continue to play fast and loose in the face of looming catastrophe – each seemingly about to founder between the Scylla of economic inevitability and the Charybdis of an ECB intransigence which is fully buttressed by the craven mendacity of those northern politicians who have tried to pretend that the dispelling of that illusion of EMU ‘convergence’ on whose maintenance they have long staked their careers will bear no direct consequences for their own electorates.
Beyond this we must repeat our recent – and ever more widely echoed – musings about the vulnerability of a French nation almost completely bereft of any fiscal sea-room while it wallows, rudderless on the lee shore of its intrinsic lack of industrial competitiveness and as its leaders either squabble on the bridge or fly hither and yon as diplomatic busybodies, full of empty pretensions to winning La Gloire abroad.
In recognition of this, no less a figure of the European left than Gerhard Schröder – the former German Chancellor and the present, heavyweight sponsor of prime SPD candidate (and after-dinner entertainer par excellence) Peter Steinbruck – has publicly called upon President Hollande to admit that his election promises cannot possibly be kept; that the lowering of the retirement age cannot be financed; that his taxation policy will lead both to capital flight and to lower job creation; and that problems will arise as soon as France starts to struggle to rollover its debts.
In France itself, the employers’ lobby Medef has talked of an economic ‘hurricane’ afflicting its members and of business leaders being in a state of ‘quasi panic’ at the prospect of a further turn of the screw. Bearing this out, the INSEE reading of employer expectations for their own future production has slumped to a two standard-deviation low, putting it well down among the depths recorded during the GFC, the Maastricht crisis, and the turmoil of 1983 when a former socialist President – François Mitterand – nearly wrecked the ship of state in his turn.
All this is taking place in a land which was the locus of much of the dreadful banking policy which financed the boom and, ergo, is the place for whose defence the current, ill-conceived interventions have largely been concerted. It is a country clearly in decline. The current account has slid, slowly but surely, from the typical surplus of around €40 billion-a-year when the euro was launched to the point where the French are now piling up an equal-and-opposite deficit of €40 billion a year. Debt/GDP has doubled in twenty years to reach a ratio of close to 90%. Overall unemployment has hit a 13-year high, with 25% of those under-25 officially currently out of work. Total employment has barely grown in a decade, while almost half the country’s manufacturing jobs have disappeared over the past generation.
Taxes are already at their highest proportion of private income in more than a decade helping the state spend an eye-watering 55% of GDP (where, naturally, its outlays greatly outstrip private, net income) and yet all M. Hollande can think of to do is to expand its enervating sway even further. Hardly the best way to promote a national revival, one feels.
Whether the ECB can afford to make good on the Draghi boast in the case of Spain is one thing (whether it can do so by adhering to its own rules on collateral eligibility appears to be a second!). Whether it could go beyond that and shore up an increasingly restive Italy is another. But the idea that it could then keep France afloat in its hour of need seems altogether a stretch too far. Even such consummate operators as Merkel and Schäuble would struggle to tell their weary voters that the only way to avoid another, Versailles-scale transfer of resources to Paris would be to undergo another socially-destructive bout of unbridled monetary inflation.
If the Hollande administration does as expected, it will this week reaffirm its purblindness by quietly burying the forthcoming report on national competitiveness being compiled by former EADS boss Louis Gallois. Worryingly wedded to the failed prescription of the Keynesian mainstream – and hence terrified that consumption will suffer, however unaffordable it may be when production is so unprofitable – ministers have already spoken out against Gallois’ eminently sensible suggestion to cut welfare payments, to lower employment charges, and to hike VAT as a budgetary offset – which combination would make work pay better for both contracting parties while introducing many of the rebalancing forces to be expected of an internal devaluation without entraining many of its unnecessary side effects.
Here, in the response to Gallois’ report, we may look for our first indications of whether France’s political elite are even aware of the monumental nature of the task which confronts them. If not, we may begin to end our doubts about whether their policies will end up posing the greatest threat to the Grand Project by which they and their predecessors in office have long set such great store.
The minor uptick in China’s ‘flash’ PMI estimate for October – from 47.9 to 49.1 – has sparked the usual explosion of uncritical hopefulness (on the part of those who, by and large, thought there never could be a slowdown under the aegis of the all-powerful CCP to begin with,) that this finally marks a bottom in that country’s economic cycle.
In giving vent to such optimism, the Sinomaniacs conveniently overlooked the fact that much of the improvement was down to the fact that it was the price indices, rather than those relating to output or employment, which struggled back above the expansion/contraction threshold of 50 – a circumstance which might just temper their extend-and-pretend expectations of an ever-imminent monetary relaxation, were they to reflect on it for a moment between jubilations.
Worse still, the Pollyannas appear to have forgotten that the PMI simply gauges whether things are generally better or worse than they were last month – and that in a non-quantitative manner, to boot. The unequivocal answer is worse (if marginally so, this time) for the twelfth consecutive month and for the fifteenth out of the last sixteen occasions. Thus, it may be true that the rate of decline seems to have slowed – how enduringly, only time will tell – but the fact of that ongoing decline itself remains, even after so many uninterrupted months of economic deterioration.
China bulls and the other assorted, ‘next quarter’ blue-skyers may have either venal or psychological reasons to puff this one reading up as a sign of a coming (and oft-postponed) dawn, but the test of an analyst who knows his stuff – and who is not afraid to be honest with you – is whether he makes this simple, but crucial, distinction in his commentary.
Of course, such an outpouring of positive sentiment will be very much to the taste of those in Beijing who have managed the seemingly miraculous feat of going into the Party Congress to the glowing accompaniment of an official GDP series which has been accelerating all year, quickening from a 6.1% annualized pace in the first quarter to 8.2% in the second and a resounding 9.1% in the third.
The fact that those same quarters have seen rail freight traffic slow from 3.7% YOY to 0.8% and on to a contraction of 5.8%; or have witnessed Shanghai port container throughput reverse from an expansion of 3.5% YOY to a shrinkage of 1.2% is, apparently, not to be invested with any significance.
Nor is the fact that while industrial production is officially up 10% YTD, those same industries have managed to consume smaller and smaller marginal increments of electrical power along the way; sliding, month by month, from a 4.1% YOY gain in March to a 3.2% one in June and on to a paltry 0.9% increase in September (which slender, overall uptick was comprised of an actual fall in heavy industrial usage).
In much the same manner, apparent consumption of refined oil products was up only 3.4% YTD, with diesel barely ahead at +1.1%. Again, not much evidence of a robust economy, there.
As the slowdown progresses, everywhere but in the reports of the authorities and the minds of their cheerleaders, profits have collapsed in their turn. So far this year, the chemical industry has seen earnings decline 18.1%; cement makers returned 53% less than in 2011; flat glass makers swung to a loss equivalent to around one-third of last year’s reported profits. Miners – whether ferrous or non-ferrous – saw income slip by around 5%, while that accruing to smelters/processors in the first group slumped by no less than 81%, flattering the performance of companies in the second category, even though they themselves booked 30% less.
The other side to this has been a surge in the debts companies owe to one another. As Caixin reported, the China Iron & Steel Association said that, at the end of July, the amount of net receivables and net payables of the 81 steel companies it monitored were up 17.8% and 10.6% respectively from the same month the previous year.
In even worse straits, the 90 enterprises monitored by the China National Coal Association reported an increase of 48.7% in net receivables from 2011, while the China Machinery Industry Federation said those for its members were up 16.9% YOY to a monster CNY 2.5 trillion. No wonder Caterpillar announced it was ‘ramping down’ production in the country.
To see these trends in a little more detail, let us examine those cosseted children of the latest economic cycle, the SOEs. These reported 9-month revenues of CNY 31 trillion which represented a relatively anaemic 9.5% gain from the like period in 2011 when sales had stormed ahead by almost a quarter from 2010. Costs were up 11.1% and hence profits fell a sharp 11.4% to CNY1.6 tln.
That represented a nominal ROE of 5.1% overall, split as to 5.5% for the centrally-controlled firms and a bare 2.9% for their local peers – which latter therefore made a big fat zero in real terms after accounting for the concurrent rise in consumer prices.
Even that does not tell the full horror of the troubles afflicting them, for the simultaneous rise in the tally of accounts receivable amounted to 1/3 of those ostensible ‘profits’ (the overall stock of receivables now stretches to 1.7 times annualised earnings), while inventories swelled by an amount equivalent to the whole of reported income. Days’ sales of inventory rose from 83 to 94.4, while days of receivables climbed to 31.8 from 28.8, putting their combined drain on working capital up to a whopping 126 days-equivalent!
So, here we have a bleak vista of mounting credit, declining margins, unpaid bills, underemployed capacity – even the rare earth market has swung so far from dearth to glut that plant is now being mothballed! – and there also remains precious little hope for making non-operating gains by diverting preferentially-granted credit into a bubbling property market. A clear indicator of this stress is that credit (deferred payment) is rising much faster than money (immediate payment).
This is an ugly constellation indeed, especially since it is giving rise to official concerns about the state of local government finances. Faced with slowing – even falling – tax revenues, these latter are squeezing already pincered companies by demanding advance payment of taxes, as well as by organizing sweeps whose aim is the mass-levying of ‘fines’ for alleged regulatory violations (presumably something of a shock after all these years of turning a blind eye in the pursuit of growth at all costs). These are also, of course, the very same local authorities who are nursing the sickliest of the SOEs and they are the same institutions who will supposedly be riding to the rescue by showering trillions of yuan on even more infrastructure and real estate developments of dubious commercial worth.
According to a report issued by the Development Research Centre of the State Council, the final months of this year will be critical to the pretence of providing ‘stimulus’ via this medium as something of the order of two-fifths of all local government debts fall due by the end of this year, with another 10% or so scheduled to mature by the close of 2013.
Having all but tripled in the last six years, something in excess of CNY11 trillion is now owed by such entities – largely through the conduits offered by the infamous ‘financing vehicles’ – leaving Wei Jianing, deputy director of the Macroeconomy Department at the DRCSC, to fret that: “There are worries over whether local governments could pay off the principal and interests when the repayment hike comes.”
Presumably Mr Wei will be taking little comfort from the happenstance of a nugatory uptick in the Purchasing Managers’ Index!
Far across the Senkaku Islands, Japanese money supply has been decelerating from its recent impressive lick, while small business confidence has plummeted below even the post-Fukushima trough. Meanwhile, the nation’s exports languish at levels first seen in 2004, thanks to the toxic mix of the fallout from the territorial spat with the Chinese and the general Asian weakness – also evident this week in Singapore (IP -2.5% YOY), Thailand (manufacturing output off 13.7% YOY to rest where it was in 2007), and the Philippines (exports off 9% YOY to stand no higher than in 2005).
All this sufficed to bring about a record trade deficit of close to Y1 trillion in Japan itself last month, at which point it was threatening to swallow the large monthly investment income component whole and, hence, to restrict the growth of the capital pool on which the country so heavily relies.
Nothing daunted, after two decades of bluebottle-against-a-windowpane policy-making, the country is again to be dosed with the same old, ineffective, patent medicine as the BoJ prepares to increase its version of QE by a cool Y10 trillion ($125 billion), some of which will help fund the already over-indebted government’s imminent Y700 billion fiscal injection.
You would think they would long since have have learned the futility of what they are about; the fact that this has eluded them for all these years should worry us greatly about our own masters’ willingness to draw the correct lessons on that grim tomorrow when their own programmes are undeniably seen to have failed. Can we not admit it is folly always to resort to the crude economics of a Krugman – the macroeconomic equivalent of the château generalship of the Somme – and to whine that we have only failed because we have not thrown enough money or lives into the fray.
In Europe meanwhile, the gaudy circus of summitry has again rolled through town to little effect. Greece seems to be back to playing brinkmanship with the Troika. ‘Two more Years of Foot-dragging’ was the headline in one German newspaper as it was rumoured that our inveterate Hellenic hand-out seekers were about to pouch another €20 billion, together with extended payment terms and a reduced coupon on their Pelion upon Ossa of existing loans. Talk about creating financial zombies!!!
Draghi bearded the lions in their den when he dissembled before the Bundestag, giving them his earnest that he would never exceed his mandate; that it was simply inconceivable that his unlimited bond purchases could be construed as monetizing state debt, or that it could in any way turn out to be inflationary.
No-one asked the obvious question that if all this was true, and if the OMTs were to exert such a subtle influence on the economy, why he felt compelled to ride roughshod over the (adopted) traditions of the institution he heads in order to implement them.
Among the few dissenting voices was that of the president of the German Savings Bank Association, Georg Fahrenschon, who declared that: “Private savings should not be further penalised. The ECB should not direct itself to minimizing the outlays of the debtor countries, but to ensuring monetary stability, today, tomorrow, and the day after that”
At the same press conference, however, he revealed the schizophrenia which Draghi’s actions have induced. German savers prefer to hold their wealth in the form of savings accounts – out of distrust and uncertainty – yet half of them see a house as the best guarantee for their old age and a third of them intend to buy one now.
If the former impulse gives way only a little in favour of the latter, that double-digit rate of increase in the local money supply will soon deliver the thrifty German burgers, almost the last of their breed, into that vortex of balance sheet ruination which is widely seen (if less openly articulated) as the real key to solving Europe’s otherwise intractable debt crisis.
Before then, however, it would seem that the country might be in for more testing times than has been the case to date. Certainly the decline in the IfO index this past six months – registered despite a rising stock market and a diminution of the sense of crisis in the Zone – is of a magnitude which has typically accompanied significant downturns in activity. With monetary creation running so hot in Germany, it would be unusual, to say the least, for revenues and profits to fall sufficiently far to trigger a serious setback – which is essentially what the IfO index is telling us is expected to occur – but nevertheless this does bear close attention.
Finally, there are one or two hints that the US is starting to sputter. Certainly, the rapid decline in core (ex-defence and aircraft) capital goods numbers tells us so. At -10% YOY, orders are now falling at the sorts of rates experienced in both the Tech bust and the GFC itself. In the past three months, nominal levels have come to rest where they were in the late 1990s while, in real terms, the series has not been this depressed since it was first compiled in the current form, two decades ago.
Those, like us, who have tended to regard the States as the best of a bad bunch, will have to hope this is nothing more than a little pre-election caution and that it will be accordingly reversed in a month or two’s time.
In its October 2012 World Economic Outlook report the International Monetary Fund (IMF) said that the European Central Bank (ECB) should keep interest rates low for the foreseeable future and may need to cut them further given the risk of deflation.
Now, even if the IMF is correct and prices in the Euro-zone will start falling, why this is so bad?
The conventional wisdom holds that price deflation causes people to postpone their buying of goods and services at present on the belief that the prices of these goods and services will be much lower in the future.
Hence why buy today if one can buy the same good at a bargain price in the future? As a result a fall in consumer outlays via the famous multiplier will lead to a large decline in the economy’s rate of growth.
In fact deflation could set in motion a vicious downward spiral, which could plunge the economy in a severe economic slump similar to the one that took place during the Great Depression of the 1930’s, or so it is held by most experts.
It is for this reason that the IMF is of the view that the ECB should push the policy interest rate further down.
Now, if deflation leads to an economic slump then policies that reverse deflation should be good for the economy.
Reversing deflation would imply introducing policies that support general increases in the prices of goods, i.e., inflation. This means that inflation could actually be an agent of economic growth.
According to most experts, a little bit of inflation can actually be a good thing. Mainstream thinkers believe that inflation of 2% is not harmful to economic growth, but that inflation of 10% could be bad news.
We suggest that at a rate of inflation of 10% it is likely that consumers are going to form rising inflation expectations.
In response to a high rate of inflation, consumers will speed up their expenditure on goods at present, which should boost economic growth. So why then is a rate of inflation of 10% or higher regarded by experts as a bad thing?
Monetary pumping will undermine economic fundamentals
Contrary to IMF thinking, a strengthening in the pace of money supply rate of growth and a further lowering of interest rates will not strengthen economic fundamentals but will further weaken the Euro-zone ability to generate real wealth. Monetary pumping and a lowering of interest rates leads to misallocation of resources – it diverts real wealth from wealth-generating activities towards non-productive wealth-consuming activities thus putting pressure on the overall pool of real wealth.
As a result the sovereign debt crisis will only get much worse since the ability of various governments to honour their debt repayments will only weaken further. Remember a government is not a wealth generating entity; it can only pay its bills and repay its debt if the private sector generates enough real wealth for that.
Now, contrary to the popular way of thinking, inflation is not about a general rise in prices as such but about increases in the money supply. Likewise deflation is not about a general fall in prices as such but about a decline in the money supply.
As a rule, a general rise in prices occurs on account of previous increases in money supply. Likewise, a general fall in prices occurs on account of previous fall in the money supply.
Following the definition that deflation is about a fall in the money supply, which can manifest through a decline in the prices of goods and services, one could infer that deflation cannot emerge without previous inflation, i.e. previous monetary pumping.
The key factor behind a fall in money supply is the central bank’s policy, which inflates the money supply. Once the side effects of this inflation become unacceptable to central bank policymakers they reverse the loose stance.
Once banks’ lending out of “thin air” – which emerged on the back of the loose monetary stance of the central bank, starts to evaporate – the money supply follows suit.
Obviously, on account of deflation, i.e. a decline in the money supply, various bubble activities that emerged on the back of previous loose monetary policy of the central bank come under pressure – they cannot stand on their own feet without the support of loose monetary policy.
The demise of bubble activities is great news for wealth generators; they can now have more real wealth for themselves and employ it in the expansion of the overall pool of real wealth.
Fall in prices enables the spread of real wealth across the economy
We suggest that a fall in prices that follows the decline in money supply is the mechanism that enables wealth generators to spread the increase in real wealth across the economy. A given dollar can now secure more goods and services – the purchasing power of the dollar is now rising. Why then should this be regarded as bad news?
Contrary to the popular way of thinking, there is nothing wrong with declining prices.
According to Salerno,
In fact, historically, the natural tendency in the industrial market economy under a commodity money such as gold has been for general prices to persistently decline as ongoing capital accumulation and advances in industrial techniques led to a continual expansion in the supplies of goods. Thus throughout the nineteenth century and up until the First World War, a mild deflationary trend prevailed in the industrialised nations as rapid growth in the supplies of goods outpaced the gradual growth in the money supply that occurred under the classical gold standard. For example, in the US from 1880 to 1896, the wholesale price level fell by about 30 percent, or by 1.75% per year, while real income rose by about 85 percent, or around 5 percent per year.
Moreover, to suggest that consumers postpone their buying of goods because prices are expected to fall would mean that people have abandoned any desire to live in the present.
However, without the maintenance of life in the present no future life is conceivable.
On this Menger wrote,
An imperfect satisfaction of needs leads to the stunting of our nature. Failure to satisfy them brings about our destruction. But to satisfy our needs is to live and prosper. Thus the attempt to provide for the satisfaction of our needs is synonymous with the attempt to provide for our lives and well-being. It is the most important of all human endeavours, since it is the prerequisite and foundation of all others.
Now, from December 1997 to August 2012, the prices of personal computers in the US have fallen by 94%. Did this fall in prices cause people to postpone buying personal computers?
On the contrary, since December 1997 consumer outlays on personal computers have increased massively. These outlays stood at $123.050 billion in August 2012 as compared to $3.4 billion in December 1997 – an increase of 3,519%.
Summary and Conclusion
In countries such as Greece and Spain what is currently required is the establishment of the conditions for a quick build-up of real wealth. Printing more money and providing more loans to these countries governments is not going to be of much help. On the contrary it will deepen the economic impoverishment and will prolong the economic misery.
What is currently needed is to cut government outlays to the bone and the closure of all the loopholes for the creation of money out of ‘thin air”.
The government and the central bank should step aside and allow entrepreneurs to revive the process of wealth generation, i.e. allowing the private sector to build up the national pie.
The major threat to the Euro-zone comes not from a possible general fall in prices but from the IMF’s recommended policies that once implemented is going to weaken further the process of wealth generation.
 Joseph T. Salerno An Austrian Taxonomy of Deflation presented at “Boom, Bust, and the Future,” January 19,2002, The Mises Institute, Auburn, Alabama p 8.
 Carl Menger Principles of Economics New York University Press p 77.
Dr Frank Shostak is a leading Austrian economist and director of Applied Austrian School Economics Ltd, which aims to assess the direction of various markets using the Austrian School methodology. AASE aims to make Austrian economics accessible to businessmen. | Contact us
16 October 12 | Tags: deflation, ECB, Inflation, Menger, Salerno | Category: Economics | One comment
Finally, the great day has come and gone when the Fed would once again ride to the action, not daring to be left behind by the ECB’s perverse vaunting of its new ‘unlimited’ programme of bond purchases and too impatient to attend the continually postponed policy shifts so long expected from both the PBOC and the BOJ. A few months of less-than-stellar macro numbers, coupled with a lull in the rise of the price indices which was helped along by the last cyclical downturn of commodity prices (alas, for the ordinary American housewife, long since reversed) and the Mighty Oz was free to rummage deep into his carpetbag of gewgaws and conjuror’s props, once more.
The rationale for this latest enormity is, frankly, hard to determine lest it be Bernanke’s eagerness to present whoever might replace him under an incoming Republican administration with a fait accompli and so to ensure his legacy as the worst economic ‘experimenter’ to be empowered since the dark days of Roosevelt himself (he of the breakfast egg gold price fixing; the alphabet soup price and wage dictatorship; and the enforced famine of mandated crop and livestock destruction).
So, when we received a little insight into the fevered mind of the Chairman – coming in the form of what he told an interlocutor from Reuters, when asked to explain how exactly he envisaged that his new, open-ended, $45-billion a month QE programme would work – our first urge was to utter the obsecration: ‘Spare us, Lord, from the scheming of idiot savants!”
Apart from the fact that Blackhawk Ben here seemed to hew to a particularly crude version of the Phillips curve largely disavowed by even the most unreconstructed mainstreamers (one which imagines that extra jobs can be bought if only prices can be made to rise fast enough), after five years of ever more desperate flailing to restore false, boom-time levels of activity, he appeared to have staked his all on bursting the piñata of the labour market by smacking it with the rough-hewn pole of the so-called ‘wealth effect.’
As he told the journalist in Thursdays’ post-FOMC Q&A:
The tools we have involve affecting financial asset prices… Those are the tools of monetary policy. There are a number of different channels. Mortgage rates, other interest rates, corporate bond rates. Also the prices of various assets….
For example, the prices of homes. To the extent that the prices of homes begin to rise, consumers will feel wealthier, they’ll begin to feel more disposed to spend. If home prices are rising they may feel more may be more willing to buy home because they think they’ll make a better return on that purchase. So house prices is [sic] one vehicle…
Stock prices – many people own stocks directly or indirectly. The issue here is whether improving asset prices will make people more willing to spend…
One of the main concerns that firms have is that there is not enough demand… if people feel their financial position is better… they’ll be more likely to spend, and that’s going to provide the demand firms need in order to be willing to hire and to invest…
These few, brief sentences contain such a miasma of error that it is hard to know where to begin if we are to restore a fresh breeze of economic rationale to this swamp of non sequiturs and wilful misunderstandings. It is not enough that crude, Krugmanite Keynesianism clings to the cheap parlour trick of using money illusion to fool unemployed wage-earners into lowering the reservation price of their labour, but now we must battle against banal, Bernankite Bubble-blowing – the hope that money illusion will fool cash-constrained asset owners instead.
To show what we mean, indulge us while we parse the Chairman’s words:
If we can artificially suppress interest rates to a low enough level, lots of people will forget that they got themselves into the current mess by borrowing too much the last time we did this and so they will begin to do so again – especially the would-be home-owners and condo-flippers.
If the price of homes begins to rise, those who have already borrowed to buy one will feel better off even though: (a) they will earn not one red cent in extra income because of that appreciation and (b) if they do manage to register a one-off capital gain, it can only come at the expense of the purchaser, whose acquisition of a durable store of shelter services will therefore involve a much greater, zero-sum call on his resources than otherwise would have been the case.
The stock market should also rise just because there’s more easy money chasing after a parking place. Naturally, we at the Fed could care less about the quaint notion that equities should represent a sensibly valued claim on a company’s estimated stream of residual earnings, or that capital markets need genuine prices if they are to serve any useful social function by allocating scarce savings to the prospectively best investment projects.
To the contrary, from our perspective, if Joe Soap wants to splash out to celebrate the entirely notional, potentially only nominal, and probably ephemeral gains on his 401k which we can bring about – without wondering whether the increase represents any lasting contribution to the aimed-for security of his retirement – well, in the long run, we’re all dead, aren’t we?
Companies don’t have enough ‘demand’, don’t you know, so if we can only get people to wave their cheque books at them, they will be so sure of being able to profit from this that they will offer every one of their new customers a job, on the spot!
Incidentally, we Keynesians are big on portraying consumer demand as being the driver of the economy, even though we’ve never quite been able to explain why it is that the ‘demand’ inherent in the existence of millions of hungry people in the world – all pathetically eager for an extra morsel of food – has not automatically brought about the necessary increase in agricultural output, investment, and employment in precisely the same manner that we are now presuming will be the case for, say, WalMart once we start buying in its customers’ mortgages.
Like most macromancers, what our esteemed Chairman is missing here is any concept of how a business actually functions, of how it and its peers interrelate in the overall structure of the economy, and of the critical role played by capital and time in the division of labour and the provision of goods. He is also prey to the superficial fallacy – a kind of inverted Say’s Law – that consumption somehow dictates the amount (rather than merely the composition) of production, something that has not been the case ever since Adam was condemned to earn his daily bread in the sweat of his brow and to till the ground from when he was taken.
Thus, rather than being fooled by the mantra that ‘(personal) consumption is two-thirds of the economy’, one should be clear about the distinction that its (imputation-boosted) count is actually only two-thirds of the highly-subjective statistical shorthand which is GDP – and that this is not the same thing at all! Gloves may well comprise 100% of the clothing I put on my hands in winter, but if they are all I don when I go out snow-shoeing, I’m not likely to get very far before some Good Samaritan of the Alps finds my half-frozen form and has to send forthwith for the nearest brandy-carrying St. Bernard so as to revive me.
This is a matter to which we have already devoted a great deal of time, but a brief synopsis here is probably in order.
Take, for example, the four years from 2006-9 inclusive which saw US GDP average just under $14 trillion while cash PCE came in at a mean $8.5 trillion (ergo, validating the shibboleth that the latter number equates to 60% or so of the first). Mainstream thinking may stop short here, smugly satisfied with this trivial – and circular – QED, but this is not even half the story.
We say this because, over the period in question, aggregate business revenues – i.e., the best representation of the overall circulation of goods and services throughout the economy – amounted to no less than $33 trillion a year (the vast bulk of which receipts were subsequently disbursed again, whether as above-the-line costs, below-the-line outlays, interest, dividends, or taxes).
Thus, not only was the ‘economy’ almost 2 ½ times as large as the GDP count, but every $1 of that supposedly crucial personal outlay was matched by $3 of business-to-business spending.
So, if Mr, Bernanke really wants to get ‘demand’ going, the foregoing drops a heavy hint that he would be three times as effective as he has been if he and his masters in Washington could manage to do something (or, conversely, to stop doing much of what they counterproductively have been doing) which ends up promoting greater managerial/entrepreneurial belief that not only can profits be made, but that, once made, more of them will be retained by their rightful owners.
It should also be recognised that the vast bulk of that $25 trillion in B2B expenditures is every bit as discretionary as the outlays of the most finicky of shoppers: no businessman can be compelled to keep his store open, or his factory running, if he finds the game not worth the candle, even though mundane economic analysis tends to assume without question that, far from being an adaptive, calculating, he is an unthinking automaton who can very much be relied upon to do just that, irrespective of his estimated remuneration.
More fundamentally still, it is the relationship (strictly, the ratio) between his receipts and his disbursements wherein the lies the difference between our hero’s commercial success – and so, his role in hiring, commissioning and the onward generation of orders for his suppliers – and his failure – hence, his sad duty to undertake lay-offs, cut-backs, and cancellations. Even absent net, new investment to improve and deepen the capital stocks and so raise real incomes, the overwhelming preponderance of that $25 trillion (in fact, all of it less an average $1.5 trillion before – and only $250 billion after – depreciation) represents a voluntary sacrifice of the enjoyment of present goods, undertaken merely to keep things running as they are.
The idea that such a delicate network of relative prices and differential cash-flows can be not only maintained, but enhanced, by the clumsy process of artificially forcing arbitrary quantities of money and credit into the system is at best naïve and at worst astrological in its pseudo-rationality. At root, such gross interventions as these, no matter how greatly they excite the raptures of the mainstream inflationists, ensure nothing more than the confusion of those critical accounting algorithms which help ensure that capital and labour are not being squandered. This is so because, not having the noble pedigree of the free, unhampered market, the infusions – being nothing more than the bastard offspring of the central planners’ hubristic conception – bear no definitive relationship to the generation and subsequent movement of the real goods and services whose value-giving exchange it is the sole purpose of these media to facilitate, both across space and through time.
To see this, take the simple – if extreme – example of the post-Lehman crisis itself. The Fed, we are told, by the newly-respectable brotherhood of NGDP targeters, ‘only’ had to ensure that the gross flow of money out of the funnel at the end of the economy (the $14 trillion per annum, principally in the form of final, exhaustive spending) remained unaltered and all would have been well. [We shall here ignore the fact that this would have been an impossible task to have undertaken in real time even if all the various rivalrous sects and sub-sects of NGDPers had managed to agree upon what means should have been employed, upon whether levels or growth rates of the aggregate should have been controlled, and over what horizon this was to be brought about].
But look at the facts of what did happen that year as the economy swirled around the ragged edges of a maelstrom of total collapse. Total domestic, non-MFI credit rose a modest 2.9% as the private component of this fell 2.5% while Leviathan’s appetite grew by a monster 13.7% (counting GSEs in with government itself). Meanwhile, M1 jumped 18.1%, ‘Austrian’ Money Supply (M1+, if you will) rose 25%, and M2 added a more modest 9.1%. Confusion confounded, you might say, since we are being exhorted to act to control one or more of these aggregates, depending upon which particular ‘new’ monetary school you choose to believe. But the difficulties do not end there, for worse was to come in the ‘real’ economy.
Here, the hallowed NGDP measure fell 3.7%, implying the Fed should have added X, or maybe Y, or Z in order to offset the switch in emphasis from credit to money and the concurrent slowdown in the immediate use or ‘velocity’ of that money.
But this was not the end of it, for private-sector NGDP (the important bit) fell a greater 5.7%, while the total business revenue measure which we have argued above is the real key variable, slumped to a crushing 11.5% loss. Within this the disparities were even more marked. Revenues among the extractive industries plunged 50.6% at one end of the spectrum as those accruing to health & social care rose 4.4% at the other. For profits – and hence, for both the means and the incentive to expand output and employment – the spread was even more extreme for the trailing four quarters to our two end-dates, ranging from a 73% contraction for the extractive sector to a 68% gain for the utilities (which, in part, benefited from the formers’ woes in the shape of cheaper energy inputs, again underlining the point that it is relative costs and prices which count, not absolute ones).
Again, we have to ask the targeters and reflationists: how, where, and when was the central authority supposed to have intervened in order to lessen the economic pain; and how do we know that same pain was not either intensified or prolonged, rather than mitigated, by the actions which were taken since these could not have done other than to have interfered with the market’s attempts to find proper clearing prices, to excise dead capital stock, and to marshal its combined entrepreneurial abilities for the task of laying down new capital where the evaporation of the prior bubble had revealed it to be truly useful (and, by extension, profitable) to do so?
If the Bernanke Fed had any answers then – or, indeed if it has since achieved sufficient enlightenment to justify its present burst of activism – we should be delighted to hear them. Our breath is not being held.
As a practical matter, it should be noted that the final data which we use to plot these changes have only just begun to be made available on a delayed quarterly basis and, even then, a full check on their validity awaits the glacial progress of the statisticians at the IRS, whose findings can be up to four years in arrears!
Though we must always exercise caution regarding any use of aggregates, a reasonable proxy is therefore what we need if we are to monitor developments, albeit using the broadest of brushes. For us the widely-ignored business sales data fits the bill for overall activity, while the ratio of its sub-components—retail sales versus those made in the manufacturing and wholesale sectors gives us an idea of gross saving/investment v end-consumption. Another way of showing this is to plot the monthly personal consumption estimates against those for business revenues. As the plot shows, this latter is highly variable and has been in decline ever since the financialization of the economy began in earnest in the early-1980s.
A falling ratio implies, to an Austrian, that a greater degree of time preference appears to be developing and hence, a higher natural rate of interest (the ratio of intertemporal prices) has come to prevail.
In contrast, an examination of the path of BAA bond yields shows that market rates (after subtracting consumer price changes) have been steadily falling over time, due to a toxic mix of loose money and abundant speculative leverage. The gap between what should be and what is, is therefore a widening one, suggesting that a mix of overconsumption and malinvestment, fuelled by increased non-productive indebtedness, is to be expected.
Chronic and often highly elevated current account deficits (not to mention the dire fiscal situation) testify to the overconsumption element, while the series of ever-more violent booms and busts, coupled with lacklustre real net investment and stagnant real wages, are symptomatic of the second, while the level of debt itself should itself need no further comment.
Given this malign constellation of factors, the Fed’s eagerness to suppress all interest returns for at least the next three years and for as far out the curve as its tainted grasp can extend is not likely to do anything to restore a much-needed touch of balance to the world’s largest (and formerly most vibrant) economy.
Bond yields have already been forced far too low, making stocks seem relatively well-valued, even as the underlying conditions deteriorate and the fatal dependency on the sweet neurotoxin of stimulus deepens its grip on the patient. By progressively suppressing the economy’s intrinsically-generated price signals in this fashion, a wholesale paralysis of the system may one day result.
What Bernanke’s intellect cannot seem to encompass is the thought that if a man has lost weight through an illness related to his previously poor dietary regime, it will simply not do to try to fill out his now-baggy suit by tempting him back into over-indulgence. Some glimmerings of this idea do surface in the occasional expression of doubt about just how large such shadowy entities as the ‘output gap’ or the ‘structural growth rate’ may still be in the aftermath of 2008’s debacle, but none of these misgivings ever seem to penetrate the cranium of a man who thinks he can meaningfully reduce unemployment by stimulating junk finance in all its many forms.
It is not only that Bernanke’s policies will inevitably assist the zombie companies and the obsolescent industries to absorb scarce resources (not least on bank balance sheets) to a much greater degree than is justified, thereby denying greater returns both to their better-positioned rivals and to those nascent endeavours which could better reflect unalloyed consumer preferences and whose growth could come to replace yesterday’s failures as tomorrows’ providers of income. There is also the danger that lax money misleads even today’s supramarginal businesses into over-estimating the depth and duration of demand for their products, ultimately undermining many otherwise sound undertakings and reducing these, too, when the cycle next turns, to the ranks of the Living Dead.
Gather ye rosebuds will ye may, for the bloom on this Fed rally, too, will eventually wither and fall.
Recently we have noticed that many more commentators and various important experts have been advocating aggressive monetary pumping by the European Central Bank to fix the economic crisis. Latest Euro-zone economic data continues to display weakness. The IFO institute German business climate index fell to 103.3 in July from 105.2 in June and 113 in July last year. Manufacturing activity as depicted by the Euro-zone purchasing management index (PMI) fell to 44.1 in July from 45.1 in the month before and 50.4 in July last year.
In the July 20, 2012 edition of the International Herald Tribune a columnist Anatole Kaletsky wondered why it is that Britain, Japan and the United States, despite their huge debts and other economic problems, have not succumbed to the financial crises that are threatening national bankruptcy in Greece, Italy and Spain?
According to Kaletsky the ability to print money has allowed the British, Japanese and US governments to run whatever deficits they wanted and to offer their banks unlimited support without suffering the sky-high interest rates that are driving Greece, Italy and Spain toward bankruptcy. Kaletsky then argues that in some circumstances, the financing of deficits by central banks can be extremely dangerous because it can cause rapid inflation. However at present he holds,
The world today is not threatened by inflation and overspending, as it was in the 1970’s and 1980’s. Instead, the danger is generally thought to be deflation caused by inadequate investment, weak consumer spending and falling wages, as in the 1930’s.
Hence concludes Kaletsky
A policy of money printing that would rightly have been denounced as counterproductive and irresponsible 40 years ago is now both necessary and prudent.
Kaletsky is of the view that if the ECB were to follow this advice, the euro crisis would soon be resolved. He warns that failing to lift the money printer will sink the Eurozone further.
Mr Kaletsky is in a supposedly good company here, on Wednesday 18 of July 2012 the International Monetary Fund issued a report publicly urging the European Central Bank (ECB) to implement a sizeable program of money printing by buying government bonds in order to fix the economic crisis.
Similarly, a famous Harvard professor of economics, Martin Feldstein, in his article in the Financial Times on 24 July 2012 supports aggressive monetary pumping by the ECB.
The Harvard professor is of the view that strong monetary pumping will lead to a strong depreciation of the Euro versus other currencies, which in turn will boost the Euro-zone’s exports. This in turn will ignite overall economic activity in the Euro area, argues our professor.
The main message from various experts and various influential columnists, as one can see, is that in order to solve the euro crisis the answer is to print money.
Accepting this way of thinking, on Thursday July 26,2012 The European Central Bank (ECB) president Mario Draghi said that ECB policy makers will do whatever is needed to preserve the euro. At the Global Investment Conference in London he said,
Within our mandate the ECB is ready to do whatever it takes to preserve the euro … Believe me, it will be enough.
In short what the ECB president is telling us that he is going to loosen further the ECB’s monetary stance. This means that he could lower the ECB policy rate further – currently at 0.75% – perhaps to zero. The president might consider lifting the pace of money pumping by boosting the ECB balance sheet (buying government bonds of countries such as Italy and Spain). Note that the yearly rate of growth of the ECB balance sheet stood at 57.1% in July versus minus 2.1% in July last year.
The underlying thinking here is that with more money in the hands of individuals, spending on goods and services will go up and this, via the famous Keynesian multiplier, is going to amplify the overall production of goods and services.
Likewise, through the depreciation of the Euro, the increase in the demand for exports will set in motion an overall increase in the production of goods and services in the Euro-zone.
What we have here is the view that demand triggers supply, i.e. the production of goods and services. At present it is held that the demand is somewhat scarce and prevents the emergence of economic prosperity.
In this way of thinking, if individuals are reluctant to increase their demand for goods and services then the government and the central bank must step in to boost demand in order to revive the economy – note that in this way of thinking spending by one individual becomes income for another individual. Hence, the more that is spent, the greater the income becomes.
Why is this way of thinking erroneous?
It is overlooked here that without funding it is not possible to exercise any demand. For instance I have a desire for a luxurious car such as a Mercedes 600 yet my means are sufficient only to secure a bicycle. Obviously, then, it will be difficult for me to secure the Mercedes 600 without the necessary means. Contrary to popular thinking, means are not something that can be printed, they have to be produced.
For instance, if a baker wants to secure apples he has to produce and save enough bread for this. Let us say that to secure 1 kilogram of apples the baker must have at his disposal 8 loaves of bread. (Let us say he has produced 10 loaves, consumed 2 loaves, and saved 8 loaves).
If he wants to secure a car he might need to have 100 loaves of bread for that. If, however, he can only produce 10 loaves then he would have difficulty to purchase the car.
To be able to do so he would need to invest his saved bread in the upgrading of his oven. He would have to pay the oven maker his saved bread. With a better oven he is now in the position to lift the production of bread. This will enable the baker to save more and secure goods that previously he couldn’t afford.
Note that what made it possible is real savings, i.e. saved bread that enabled the baker to boost the production of bread. Also note that if the baker would only increase his demand whilst his savings is still 8 loaves of bread, it will not result in an increase in the production of bread.
Similarly if the central bank was to print money it cannot boost the production of goods without previous investment in the infrastructure. The printing of money would only boost demand, which is not supported by a previous production of real wealth, i.e. final goods and services.
Likewise, a depreciation of the currency in response to monetary pumping will lead temporarily to a boost in exports by diverting real funding from other activities. However, over time this will make things much worse. (To accommodate the increase in foreign demand one must have the infrastructure for that).
One could of course argue that currently in the Eurozone there are plenty of idle resources, which could be employed. It is overlooked here that the employment of so-called idle resources requires real funding. If the current infrastructure is not capable of generating a sufficient amount of real funding it will be impossible to accommodate an increase in the demand for goods and services. (Note that resources are made idle in the first instance on account of policies that resulted in the misallocation of resources and the depletion of the pool of real funding).
Contrary to popular thinking, printing money cannot replace non-existent real funding. Money is just a medium of exchange; it is not the means of real payment. Individuals are paying for goods with other goods; all that money does here is to facilitate the payment of one good for another good.
Consequently, printing more money doesn’t generate more real funding but rather leads to an exchange of nothing for something, i.e. to the depletion of the pool of real funding. It leads to a diversion of real funding from those individuals that have contributed to the pool of real wealth to those who made no contribution whatsoever.
So how then can the Euro-zone crisis be solved?
We suggest that this has to be done through an increase, as much as possible, of the pool of real funding – the increase in this pool is the key to the increase in overall wealth and hence in the increase in the well being of individuals.
This means that what is required here is to seal off all the channels that undermine the formation of real funding and hence real wealth.
We hold that the key channels that weaken this formation are government outlays and the central bank’s loose monetary policies.
This means that one needs to seal off all the loopholes of monetary pumping and to cut government outlays to the bone. Observe that cutting government outlays makes it possible to lower all sort of taxes on individuals.
This enlarges the amount of scarce funding in the hands of the private sector. (Note that the focus should be on cutting government outlays and not on cutting the deficit as such). As a result of this more real funding will now be in the hands of wealth generators, which we suggest will get things going in no time.
It must be understood that no central bank or government tampering with markets can make the overall “pie” bigger – all that these policies as a rule generate is a redistribution of a given “pie”. Note that over time these policies lead to a weakening in the formation of real funding and economic impoverishment.
Summary and conclusion
What is required to solve the Euro-zone crisis is to allow as soon as possible wealth generators to get on with the job of wealth creation. For this to occur the government and the central bank must reduce their interference with markets – the sooner this happens, the faster a true sustainable economic recovery will emerge.
Dr Frank Shostak is a leading Austrian economist and director of Applied Austrian School Economics Ltd, which aims to assess the direction of various markets using the Austrian School methodology. AASE aims to make Austrian economics accessible to businessmen. | Contact us
2 August 12 | Tags: ECB | Category: Economics | 4 comments
On August 15, 1971, President Richard Nixon declared that the United States would no longer honour its promise to exchange US dollars held by foreign central banks for gold at a fixed price of $35 an ounce. The innocuous term ‘Nixon closed the gold window’ that is now widely used to describe this act does not quite convey its significance. (Was something to be stopped from going out or from coming in through the window? Can the window be reopened again?)
What Nixon did was cut the last remaining official link between the world’s leading reserve currency and gold and thus remove the last constraint on fiat money creation.
Was this a big deal? – It was very big deal. In fact, we are only now beginning to realize the full consequences of it. In fact, the present crisis is nothing but the endgame of this system, or non-system — of this, mankind’s latest and so far most ambitious, experiment with unrestricted fiat money. The first truly global paper standard.
Nixon knew that it was big. On TV that day he felt compelled to reassure the American public that this was only temporary and that the purchasing power of the dollar was secure. Forty-one years later we are still on the same system (or non-system), and the dollar has lost eighty percent of its purchasing power.
But the mainstream economists, who weren’t even involved in designing this system (or non-system) — as nobody designed it, it was simply the result of political opportunism — these economists today tell us that this system is great, it is to our advantage. We should be grateful for it.
Because the eighty percent drop in purchasing power isn’t the whole story, that is only CPI, the consumer price index. For the past thirty years, a lot of the newly created money was channelled predominantly not into the markets for consumer goods but into the stock market, the bond market, the real estate market, and again the bond market. This created illusions of wealth. It also created a lot of debt, overstretched banks, a gigantic financial industry, various bubbles, and yet more debt. It did so around the world. And whenever this house of cards looks like it could come crashing down on us – we print more money!
Simple. What can go wrong?
Of course, there was also real economic progress over those forty-one years. Entrepreneurship, trade, innovation, saving, and all that old fashioned stuff that modern, enlightened economists don’t talk about any more. But on top of that real prosperity an ever thicker layer of make-believe prosperity accumulated. And our economists have adapted to this new reality – a reality created not by them, or their theories, but simply borne out of cynical political expediency – and become experts in the various techniques of governments to create illusionary prosperity and short-term growth spurts. Stimulus. Growth through low interest rates. Growth through more debt. Growth through currency debasement. Growth through fiscal policy. Growth through monetary policy.
Modern economists don’t know capitalism. They certainly don’t care about it. If the economy grows it is because of good policy, which means low interest rates and stimulus. If the economy doesn’t grow, it is because of bad policy, which means interest rates are too high (even if they are zero) or the central bank does not print enough money. Since Nixon ‘closed the gold window’, we have progressively replaced savings with cheap credit, the market with policy, and entrepreneurs and innovation with the FOMC and the G20.
Since 1971, the number and intensity of banking crises around the world has gone up markedly, according to Carmen Reinhart and Kenneth Rogoff, hardly anti-establishment economists. Debt levels exploded. The ten years up to the start of this crisis in July 2007 have seen house prices in the US rise ten times faster than over the previous one hundred years.
Look around the world today. Is it a coincidence that all major central banks are at zero interest rates to support bankrupt banks and bankrupt governments the world over?
Bizarrely, it is today the advocates of sound and hard money who are made to explain their atavistic ideas. — Gold standard? To establishment figures like Lord Skidelsky, the advocates of a gold anchor are like druids who dress in strange clothes and worship ancient gods – rather than, as befits the enlightened modern economist, worship at the altar of Keynes, the IMF, and big government. And ex-central banker DeAnne Julius simply knows that it would be foolish to return to a gold standard. All power to the bureaucracy!
What I find fascinating is how many intelligent people are willing, even feel urged, to provide intellectual support for a system that is not the result of intellectual discourse but came about – rather non-intellectually – through sheer power politics, opportunism and hubris, and that is evidently failing. Our financial system (or non-system) offers a great example of Nietzsche’s dictum that investigating the true origin and the true motivation behind things most often leads to surprising results. The purpose and the clever design that most people later believe to be behind various institutions are often only projected onto them with hindsight.
Even more bizarre is the willingness to absolve the political class of their responsibility for the disaster they have inflicted on us, and to even look to the political class to now save us from this ever-growing mess. There is something disturbing and sickening about the pathetic reverence of commentators, analysts and economists for the policy bureaucracy, the central bankers, the G20, the finance ministers; how every word they say is scrutinized for any hint of another clever scheme, another policy initiative that could make all our past mistakes go away and that could make the status quo operable again. “The weak labour market could force the Fed into action,” as if the Fed had the key to the solution in some drawer, as if all that was needed now was another round of QE, another rate cut, another twisty price manipulation.
I wonder if forty years of paper money have made the politicians bolder and the economists dumber. But maybe at this stage they are both simply getting more desperate.
And nothing is more dangerous to your personal and material well-being, and your liberty, than desperate politicians. Desperate politicians think that the end justifies the means. No constraints on their ad hoc decision-making can be tolerated. Laws must be changed if they stand in the way.
On October 27, 2010, Chancellor Angela Merkel promised the German parliament that the bailout fund EFSF (European Financial Stability Facility – you couldn’t make this stuff up!) was a temporary thing. As temporary as Nixon’s closed window, one assumes. In February of 2010, Greece had already been bailed out the first time – in contravention of the no-bailout clause in European treaties. Now a bailout fund was needed. But not to worry. This is only temporary. And we know what we are doing.
Of course, as more bailouts were needed, the EFSF grew bigger. It will now be replaced with the ESM – the European Stability Mechanism, no sniggering please. And this thing is, of course, permanent. (The German Constitutional Court will rubber-stamp it soon. Not to worry.)
What do our commentators and mainstream economists have to say about it? – Great! We need a big bazooka! Merkel should do more!
EVERY law, regulation and restriction that was part of the original set-up of EMU has now been broken.
The limits on budget deficits and overall public debt limits (Maastricht Criteria)? –Ignored.
The no-bail out provision? – Ignored.
The ban on ECB buying sovereign bonds to support fiscal policy? – Circumvented with the flimsiest of excuses.
Let’s face it. There is no master plan here. The political class is losing control. There is not even a conspiracy. There is a lack of control, of direction and of design. One quick-fix after another, and every one brings us a step closer to a very nasty endgame.
For the final option is always the same, not only in the Euro Zone, where new ‘hope’ just arrived in the form of Mario Draghi’s apparent willingness to buy more government debt, but also in the US, the UK, Japan, and China: print more money.
If you have no (or little) debt, if you are a productive citizen and if you have saved a bit, you are already in the crosshairs of the policy bureaucracy. Either your property will get taxed away or inflated away. Probably both.
The biggest threat to your property and to your individual liberty does not come from markets and not even from the bankers. It comes from politics.