In what was a banner week for the many serial inflationists and fans of Big Government out there, equity markets largely reversed the declines of the previous period on the hope for – what else? – yet more pump priming. Adding their vote of approval, fixed income players have also pushed junk and EM yields to new lows and touched new, post-Mario depths in BTP/Bono-Bund spreads.
On the fiscal front, much heart has been taken at EU Commission President Barroso’s assertion that the time has come to move beyond an exclusive reliance on ‘austerity’ and to begin to focus on encouraging growth. Indeed, such was the frenzy of press speculation whipped up on this account – not least by the bien pensant Guardian newspaper as part of its campaign to effect a change in British policy – that the EU’s official website quickly published a full transcript of Barroso’s remarks under the revealing title of “What President Barroso actually said” [our emphasis].
Needless to say, this was far less radical than anything whipped up by the journalists – the crux being that it was mainly matter of paying lip service to the ongoing need to trim debts and deficits, while calling for a range of largely unspecified microeconomic reforms and, as such, representing more of an exercise in expectations management than the signal of a clear break with the line being toed across the Rhine.
In the circumstances, however, the wilful desire to over-interpret (if not actively misinterpret) the message was far too powerful to resist, especially in the wake of the academic catfight going on over the state of Reinhardt and Rogoff’s Excel skills.
For those who have real lives to lead, the briefest of synopses of this spat will suffice and, indeed, it is only introduced here to illustrate the heedless Flucht nach Vorne mentality of the Krugmanites, ever eager as they are to peddle the line that the only reason stimulus has ‘failed’ is because there has been nowhere near enough of it, that the violation of both the principles of accounting and the tenets of good housekeeping on the part of the Provider State has somehow been too timid.
Loosely, R&R wrote a paper which suggested that high government debt is detrimental to growth but managed to overweight one particular input from little old New Zealand at the dawn of their sample. A caricature of the paper’s results had meanwhile been employed to argue that growth would evaporate the minute a 90% debt/GDP ratio was reached, but not an iota before. Since this, naturally, was being put about with as much conviction as would be accorded a cross between Holy Writ and Newton’s Third Law of Motion, the Left instantly seized upon the revelation of R&R’s faux pas to claim that the collapse of this particular straw man somehow ‘proved’ that all attempts at public economy were therefore misplaced and that Leviathan should return with renewed vigour to the fulfilment of its sacred duty to collectivise as much of the market as possible.
What larks, Pip, are to be had when positivists and macromancers fall out over their flawed pursuit of what Mises called ‘scientism’ – viz., the pretence affected by most of the mainstream that economics can be made into a simulacrum of physics or fluid mechanics!
But, as a focus of this war of the scholastics, the whole debt issue surely misses the crucial point that debt only swells in a polity where not only is government over large to begin with, but where it is serially profligate – i.e., where the political class persists in spending more than it dares ask its electors to contribute to the fulfilment of its whims.
Given that this diverts resources away from hard-budget, dispersed-knowledge, voluntarily-contracted endeavours (hence ones which must, over time, at the very least pay their way) and into the crony-ridden, cost-plus, soft budget quagmire of top-down, fatal conceit compulsion – every one of its endless stream of programmes a would-be Great Leap Forward – can it really be a matter of dispute that existence of a high debt level should be taken as convincing evidence of a country where the petty tyrants in office and the host of public drones which they employ have enjoyed far too much sway for far too long and so have clogged up the machinery of wealth creation with a plethora of regulations, a nest of subsidies, a tangle of vested interests, and a legacy of malinvested capital every bit poisonous as that left behind by a private sector credit bubble (itself a plague which can only be transmitted by means of a pervasive state interference in the free market)?
As Thomas Gordon wrote long ago in Discourse X of his 1753 publication, “The Works of Tacitus with Political Discourses” :-
Wars beget great Armies; Armies beget great Taxes; heavy Taxes waste and impoverish the Country
Just substitute ‘Welfare’ for ‘Wars’ and ‘Public employees’ for ‘Armies’ and the argument remains in full 260 years later.
And, since you ask, evidence of real ‘austerity’ remains elusive. Government revenues, it is true, fell – for obvious reasons – in Greece, Spain, Portugal, and Ireland in the five years after 2007, but they were still up an average of 7.2% across the Eurozone as a whole. Expenditures, meanwhile, have continued to expand, rising an average of 15%. Only Ireland has here managed to record a decrease and that of a paltry 1%. Debt has, needless to say, climbed ever upward to reach a Eurozone-wide level of 118% of non-government GDP (we prefer to measure the obligation shouldered by the Ants alone, not by them and the Grasshoppers who prey upon them). Debt/pGDP itself has climbed by an astonishing median 30% in that same quinquennium.
Now it may well be that the rise in debt during this sorry period is a consequence, rather than a cause, of the growth slowdown, but the reason for the crisis which entrained this slump nonetheless lies in the too great accumulation of debt during the boom years. That much of the offending mountain of unpayable claims was initially a private sector folly is hardly to the point: what we have always maintained is that the blank refusal to renegotiate or liquidate that debt at the earliest possible stage, instead of engaging upon an obstinate course of macroeconomic Micawberism, is why the crisis has generated a grinding depression which shows few signs of being alleviated almost five dreary years after the event.
If nothing else, today’s debt stands as a testimony to economic incomprehension and political stupidity on a tremendous scale. But then again, since we are supposed to be drawing all of our lessons from what the Americans did in the 1930s, it is no surprise that we, too, have managed to perpetuate our misery, as did the monetary cranks and bureaucratic meddlers of FDR’s crackpot Brain Trust, way back then.
David Stockman’s The Great Deformation is a tour de force of historical revisionism that demolishes the conventional economic and political wisdom prevailing both prior to and in the aftermath of the 2008 global financial crisis. Approaching his subject from many different angles, he demonstrates in thorough and specific detail, including much direct personal experience, that the roots of the crisis stretch back many decades. Few if any stones are left unturned; few if any major US political actors escape criticism; and all are subject to healthy scrutiny regardless of their orientation on the left-right spectrum. Indeed, Stockman makes clear that the facile left-right distinction of US politics obscures a deeper crisis of capitalism that spans the breadth of the American economic and political landscape. While he admits he has little hope that America can now change course, in closing he does offer a few specific policy recommendations that might, just might, lay the foundation for a Great American Reformation, were they to be implemented in future.
A most credible source
There is no more credible source for a book detailing the myriad policy failures collectively contributing to America’s decent into crony capitalism than David Stockman. Elected to Congress in the 1970s while still in his 20s, he was selected by President Reagan to be his first budget director at age 31 and was thus the youngest Cabinet-level US official to serve in the entire 20th century.
Bright-eyed and bushy-tailed in comparison to the seasoned older guard dominating the Reagan White House, Stockman became rapidly disillusioned by the striking contrast between Reagan’s lofty rhetoric on the one hand and the reality of White House policies on the other. He left politics in 1985 for the private sector and entered the world of private equity as a partner at the Blackstone Group.
As Stockman himself admits, however, he is not entirely above the criticism he levels repeatedly at others throughout the book. Three prominent examples include his admission of avoiding the Vietnam draft by enrolling in Harvard Divinity School; being repeatedly outmanoeuvred by highly experienced political operatives while serving in the Reagan White House; and bearing at least some responsibility for a handful of poor investment decisions while working at Blackstone.
This honest introspection only serves to make the book more credible. Stockman is an American taking a long look in the mirror and asking the tough questions that few in power will ask, associated as they all are, in some way, with the great tragedy he describes in thorough detail.
The first polemical punch
Stockman wastes no time in landing his first polemical punch: on the first page, he observes that the US ‘Fiscal Cliff’, around which there was such high political drama late last year, is both “permanent and insoluble,” and that the chronic US deficit and debt problem is “the result of capture of the state, especially its central bank, the Federal Reserve, by crony capitalist forces deeply inimical to free markets and democracy.”
What follows is page after page of shocking detail regarding the metastatising crony-capitalist cancer consuming the US economy’s once great potential. While primarily concerned with recent developments, a great strength of the book is that it seeks always to trace the roots of The Great Deformation back to their beginnings, for example, in early 20th century Progressivism; in President Roosevelt’s New Deal; or in the Republican Party’s fateful decision in the 1960s to sever its small-government roots.
Debunking the conventional wisdom
Throughout the book, Stockman relentlessly attacks the economic conventional wisdom. In one instance he reaches back into the Great Depression to demonstrate that numerous policy errors both in the United States and abroad contributed to the 1929 stock market crash and subsequent banking crises of the early 1930s. Moreover, he demonstrates convincingly that it was not the military Keynesianism of the 1940s that ended the Depression but rather a severe and prolonged household and corporate deleveraging facilitated by a combination of women entering the workforce en masse, a general shortage or outright absence of many consumption goods and the associated, unusually high national savings rate.
This goes directly against the mainstream interpretation that increased rates of savings only serve to make financial crises even worse. But Stockman does not stop there. He shows how the rapid public sector deficit reduction in the immediate postwar period and the general fiscal prudence of the Truman and Eisenhower years enabled the rapid, healthy, sustainable growth of the 1950s and 1960s to proceed absent any material increase in the public debt and absent inflationary pressures on prices.
This began to change during the Kennedy administration but it was under Johnson and Nixon that traditional American fiscal convervatism was shown the door for good. From this point forward, the tone of the book changes dramatically as Stockman initiates a devastating assault on the conventional wisdom: The entire left-right narrative of US politics is demonstrated to be a great charade. Even the early Reagan years in which Stockman was a direct policy participant are shown to be an exercise in the relentless growth of government, associated deficits and debt. As he explains it, “Rather than a permanent era of robust free market growth, the Reagan Revolution ushered in two spells of massive statist policy stimulation.” Indeed, Stockman characterises the Reagan and Bush years as a ‘Keynesian Boom’.
As Stockman explains, for all the talk to this day of Reagan’s fiscal conservatism, the only meaningful conservative policy victory of the time was achieved by the Fed, not the government. Paul Volcker did what was required to stabilise the dollar and bring down inflation following the disastrous stagflationary 1970s, the inevitable consequence of Johnson’s and Nixon’s fiscal largesse, the hugely expensive Vietnam war, soaring government deficits, de-pegging the dollar’s link to gold and the Fed’s accommodation of, among other associated phenomena, higher crude oil prices via OPEC.
As is the consistently the case throughout the book, however, Stockman highlights the links between failed economic policies and their unfortunate social consequences: The relentless growth of moral hazard and crony capitalism. Once Volker had left the stage, replaced by Alan ‘Bubbles’ Greenspan (sic), he explains how the Fed began de facto to target asset prices, in particular the stock and housing markets, and that “Under the Fed’s new prosperity management regime … the buildup of wealth did not require sacrifice or deferred consumption. Instead, it would be obtained from a perpetual windfall of capital gains arising from the financial casinos.” Wow.
That’s right, for decades the stock market has been a financial casino, rigged as desired by the Fed to (mis)manage the economy, and now all that is left is a “bull market culture” that has “totally deformed the free market.”
Stockman also points out how the decades leading up to 2008 were replete with ‘foreshocks’ of the eventual financial earthquake. For example, there was the S&L crisis of the late-1980s and early 1990s. There was the Long-Term-Capital debacle. And each and every time that the Fed’s economic management led, either directly or not, to near-calamity, the bailout beneficiaries were enriched anew.
With most of Stockman’s criticism is directed at Washington, Wall Street and the Fed, he nevertheless reserves some for the non-financial corporate sector. As he explains:
Alongside the Fed’s cheap credit regime, there arose a noxious distortion of the tax code best summarized as ‘leveraged inside buildup’. The linchpin was successive legislative reductions of the tax rate on capital gains that resulted in a wide gap between high rates on ordinary income and negligible taxes on capital gains. This huge tax wedge became a powerful incentive to rearrange capital structures so that ordinary income could be converted into capital gains.
In Stockman’s view there is thus plenty of blame to go around. On a few occasions he even criticises the defence establishment, holding up Eisenhower as the last example of Pentagon budgetary discipline. While he hardly comes across as a dove in foreign policy, he is certainly not as hawkish as recent administrations and he points out a handful of examples of failed defence policies and budgetary largesse past and present.
Beyond left and right
Readers who attempt to understand this book according to any variation of the current economic policy mainstream or through the obsolete left-right narrative of US politics will struggle to understand Stockman’s independent perspective. The Great Deformation is written by an old-school, small-government ‘Eisenhower Republican’ and champion of the free-market who perceives more clearly than most just how far the insidious crony-capitalist rot has spread, whether it be facilitated by purportedly left-leaning ‘regulation’ or encouraged by right-leaning tax-reform. As Stockman repeatedly demonstrates, the concept of ‘capture’ applies equally to both.
Perhaps unsurprisingly given the horrifying state of affairs he so cogently describes, Stockman is not sanguine about America’s future. The US is travelling down Hayek’s fabled ‘Road to Serfdom’ as the government and central bank respond to the damaging effects of failed interventionism with escalating interventionism. Indeed, since at least 2008, the evidence is overwhelming that America has been accelerating down that tragic road.
In closing, Stockman offers some ideas that might help the US to reverse course, although he strongly doubts that they will be adopted. If anything, the political winds from both left and right continue to blow in the other direction. No doubt his polemic will be rebuffed by those in power on both sides of the aisle in Congress and his recommendations for reform will go unheeded. That Stockman knows this, but wrote this book regardless, demonstrates his love for America. Anyone sharing that love should read it.
An essential central banking policy tool
Stop all the Bloomberg feeds, cut off all the cell phones, prevent the press from thinking with a juicy story about the failed politician’s marriage. Because the new governor of the Bank of England, the extremely well-compensated Mark Carney, has just discovered how to fix Great Britain’s economic woes. Can you guess what it is yet? Yes, you might be ahead of me on this one, but he’s going to ‘rescue’ Britain’s economy by printing more money. Who would have thunk it?
(If you can get through the Financial Times paywall, you can read about this here.)
It seems Mr Carney is going to be granted a Federal-Reserve-style mandate of ‘targeting’ both unemployment and price inflation, as opposed to just price inflation. However, since the Bank of England has failed to hit their price inflation target for quite a number of years now, who was counting anyway? This Keynesian dual-targeting of both unemployment and inflation is hilariously based on the 1958 Phillips Curve, which never really worked as a model even back in 1958 and which was repeatedly smashed on the Procrustean rocks of stagflation in the 1970s, to the point where teenage boys would laugh at economics professors who tried to teach it in the ivy league halls of the United States.
However, Keynesians never let history, lost decades, or indeed logic and the unchanging nature of the human condition, ever get in the way of a good mathematical curve, especially when completely unrelated to reality and where it can be used to justify million dollar salaries for themselves personally (once again proving the unchanging nature of the human condition).
And so, after five years of quibbling with a mere half a trillion dollars of quantitative easing, the Bank of England has finally decided to really ‘rescue’ Great Britain, just as Mr Ben Bernanke has ‘rescued‘ the United States, Mr Shinzo Abe has decided to ‘rescue‘ Japan, and Mr Mario Draghi has decided to ‘rescue‘ Euroland. It seems remarkable that they’ve all hit upon the same solution, which is to print more money. Who knew it was that easy?
So why has the Bank of England waited so long outside the western central banking party before deciding to ‘rescue’ Great Britain by flooding it with quadrillions of paper currency units? Before they drown us in yet more digital scrip, however, perhaps they ought to speak first to Mr Gideon Gono, the governor of the Reserve Bank of Zimbabwe. I’m confident he has an opinion on this crucial central banking tool.
Maybe they decided against this because money printing is the only central banking tool, and if they’re to be denied this wonder drug, they may as well just all sack themselves? Though it does seem amazing to me that you have to pay a man a million dollars a year to tell you that he’s going to swing the only golf club available in the bag. However, I suppose if he wears a suit nicely, sounds vaguely foreign, and looks ‘authoritative’ on financial news programmes, it’s cheaper than hiring Brad Pitt. We must also remember that although money printing has never done any general society any good, it has done one group of really special people lots of good, especially over the last few years, when most of them should have been made bankrupt. These people are of course the closet friends and the shadowy shareholders of the western central banks, the über-wealthy bank-rollers of the western political classes.
For they just love money printing, especially when it is used to bail out the banks they own and operate. And they’re still über wealthy as a result, when many of them should be pushing trolleys around supermarket car parks. Though collecting supermarket trolleys is honest work, and honest work is something the über-wealthy long since gave up on. Why work when printed money can steal the production of others? Just make sure that you control the people who do the printing. You can ask any mafia gang controlling a high-quality basement counterfeiter about that. And if the money you’re printing is such high quality that it is the currency of the realm, then you can laugh all the way to the Bank of England. So long as you possess the collective morals of a cackle of hyenas.
This article was previously published at TheEuroVigilante.com.
The Austrian School of economics has provided the world with devastating critics of Keynes’s magnum opus The General Theory of Employment, Interest and Money (TGT) for a long time. Friedrich A. von Hayek, Jacques Rueff, Henry Hazlitt, Murray Rothbard, Ludwig Lachmann, Ludwig von Mises, and William Hutt have already provided important arguments against Keynes and Keynesianism.
Now we can add a new name to that distinguished list. In 2012, Juan Ramón Rallo has published a new Austrian critique of TGT in Spanish with the title Los Errores de la Vieja Economía (The Failure of the Old Economics) in honor of Hazlitt’s work The Failure of the ‘New Economics’.
In Hazlitt’s time, Keynes’s program was still revolutionary and described by Hazlitt as a kind of “New Economics” that broke with the insights of classical economics and especially with Say’s Law. Now, Keynesianism is mainstream. Keynesianism, and especially its main idea that spending reduces unemployment, is still taught in universities, applied by grateful politicians, and prominently defended by the 2008 Nobel Prize winner Paul Krugman.
Indeed, the immediate political response to the current financial crisis in the Western World was inspired by TGT. A second Great Depression was to be prevented and Keynes’s insights applied. Governments engaged in loose monetary policy combined with fiscal stimulus in response to what, through Keynesian eyes, appeared to be a bubble caused by reckless speculation, which was in turn inspired by animal spirits. Thus, even if Rallo’s book were just a summary of the old arguments against TGT, the moment for publication would be more than appropriate, since the ideas of the past are still the praxis of the present.
Yet, Los Errores de la Vieja Economía is much more than a summary and synthesis of the old arguments by the aforementioned Austrian authors. Rallo builds upon, combines, and develops these arguments in a systematic way. Most importantly, he adds his own innovative ideas to develop a devastating case against TGT.
Rallo’s critique of TGT employing Austrian theory is rigorous, systematic and exhaustive. Significantly, Keynes’s ideas are not twisted or distorted. The absence of strawman arguments makes Rallo’s attack against the core of Keynesian beliefs stronger than most. Rallo also does not search for terminological contradictions and inconsistencies. In this sense, Rallo’s critique is more profound and devastating than for example the parts of Henry Hazlitt’s brilliant critique that emphasize Keynes’s inconsistencies, imprecision, and explanatory fuzziness. Rallo has a great and genuine interest in giving a clear and coherent picture of Keynes’s reasoning and presents Keynes in the most favorable light.
Let’s have a look of some of Rallo’s arguments, beginning with Keynes’s famous critique of Say’s Law. Keynes’s distorted version of Say’s Law in TGT states that supply creates its own demand. Rallo vindicates Say’s Law in its original version: in the long run, the supply of a good adjusts to its demand. Ultimately, goods are offered to buy other goods (money included). One produces in order to demand, which implies that a general overproduction is impossible.
Say’s Laws leads us straight forward to the most innovative argument in Rallo’s book that addresses the old argument against hoarding. Even harsh critics of Keynes, for example from the monetarist or neoclassical camp, admit that Keynes was at least right in that hoarding is a destabilizing and dangerous activity.
Rallo, however, proves and emphasizes the social function of hoarding. To demand money is not to demand nothing from the market. Hoarding is the natural response of savers and consumers to a structure of production that does not adjust to their needs. It is a signal of protest to entrepreneurs: “Please offer different consumer and capital goods! Change the structure of production, since the composition of offered goods is not appropriate.”
In a situation of great uncertainty, it is even prudent to hoard and not immobilize funds for the long run. Rallo provides us a visual example. Let’s assume that uncertainty increases because people expect an earthquake. They start to hoard, i.e., they increase their cash balance, which gives them more flexibility. This is completely rational and beneficial from the point of view of market participants. The alternative is to immobilize funds through government spending. The public production of skyscrapers is not only against the will of the more prudent people; it will also prove disastrous if the earthquake is realized.
Hoarding is an insurance against future uncertainties. Rallo argues that, if the demand for money increases (liquidity preference increases) due to the precautionary motive, short-term market rates of interest tend to fall, while long-term rates increase. People invest more short term and less long term in order to stay liquid. This leads to an adjustment of the structure of production. More resources will be used for the production of the most liquid good (i.e., gold in a gold standard), and for the production of consumer goods. The structure of production shifts toward shorter and less risky processes reducing longer and riskier ones. Hoarding, therefore, does not cause factors of production to be idle that shouldn’t be. Factors are just shifted toward gold production and shorter-term projects. Rallo insists that it is not irrational to hoard. Indeed, when long-term projects are maintained and economic conditions change, projects might have to be liquidated suddenly. For example, the earthquake would destroy the skyscraper in progress.
It should be noted that most Austrians do not hold a hybrid liquidity preference / time preference theory of interest. For Rallo the interest rate, or the structure of interest rates, is determined both by time preference and liquidity preference. Most Austrians defend the pure time preference theory of interest. My own position on this question can be found in this article co-authored with David Howden. Due to uncertainty an actor prefers to be liquid rather than illiquid. Due to time preference an actor prefers to be liquid rather sooner than later. Therefore, the yield curve tends to be upward sloping. When uncertainty increases, the yield curve tends to get steeper. In a financial crisis, however, another effect tends to prevail over this tendency. When society is in general illiquid, the high demand for short-term loans, the scramble for liquidity, tends to cause a downward sloping yield curve.
Idle resources are another important topic in Rallo’s book since Keynes recommends inflation in the case of idle resources. Rallo asks why factors are unemployed and comes to the result that their owners demand a price for their services that is higher than their discounted marginal value product. In these circumstances, inflation implies a redistribution in favor of the owners of those factors, or a frustration of attempts to restructure, i.e., the economy suffers from forced saving or capital consumption.
In contrast, when factors of production adjust their prices, i.e., wages fall back to their discounted marginal value product, aggregate demand does not fall as Keynes suggests. On the contrary aggregate demand increases, because total production increases.
Rallo goes relentlessly after other Keynesian concepts. The famous “investment multiplier” requires idle resources of all factors of production. More precisely, for Keynes to be right you need voluntary unemployment of all factors of production plus idle capacity in consumer goods’ industries. If there is no voluntary unemployment of all factors, government stimulation of new projects will lead to bottlenecks as factors are bid away from profitable investment projects. If all types of factors are idle, but there is no capacity in consumer goods industries, then government stimulus will raise prices of consumer goods and lead to a shortening of the structure of production. If, however, there is a general idleness of factors and idle capacities in consumer goods industries, why is there no voluntary agreement between owners of factors of production and entrepreneurs?
Another important Keynesian idea that Rallo tackles is the famous liquidity trap. A liquidity trap exists when, in a depressed economy, interest rates are very low. In such a situation Keynes regards monetary policy as useless, because speculators will just hoard newly produced money. Speculators will not invest in bonds because they are at maximum prices and will fall when interest rates finally rise. At this point monetary policy becomes impotent. Public spending becomes necessary to stimulate aggregate demand.
Rallo shows that after an artificial boom, in a situation where there are many malinvestments and a general over-indebtedness in the economy, there is indeed almost no demand for loans even at very low interest rates. We are actually faced with an illiquidity trap, as agents struggle to improve their liquidity. They want to reduce their debts and not take on more loans. The monetary policy of low interest rates actually worsens the situation, because with low interest rates, there is no incentive to prepay and cancel debts (because their present value is raised). The solution to this situation of general uncertainty is hoarding, stable institutions, the liquidation of malinvestment and the reduction of debts.
High uncertainty does not imply high unemployment, since even under high uncertainty the reduction of prices for services of factors of production renders profitable new projects. Under high uncertainty, these projects will be gold production (in a gold standard) and the short-term production of consumer goods.
As Rallo points out in contrast to TGT, it is not aggregate supply or aggregate demand that is important, but their composition. If, in a depression with a distorted structure of production, in a liquidity trap situation, aggregate demand is boosted by government spending, the existing structure cannot produce the goods that consumers want most urgently. The solution is not more spending and more debts, but debt reduction and the liquidation of malinvestments to make new and sustainable investments feasible.
In contrast, for Keynes, the problem is always insufficient demand. So what can we do if consumers and investors do not buy the goods of that companies offer, but instead hoard? Well, Keynes recommends lowering taxes and interest rates, to devalue the currency, or that the government buys the products for consumers. But, why, asks Rallo, should consumers and investors buy goods they don’t want?
Keynes’s answer is that otherwise unemployment will increase. Rallo responds astutely: but if a person is forced to buy with his salary something that he does not want, why shall this person work at all? The alternative to forced buying is to lower wages to their discounted marginal value product, which increases production and demand. As Rallo points out, society does not get richer if the government induces or forces people to buy goods they don’t want. Thus, for Rallo the essence of TGT is the following: when people do not want to buy what is produced, the government should force them to act against their will.
The insights from Rallo’s book presented here are only a small selection. Rallo also offers an analysis of Keynes’s main definitions and the theoretical errors behind them, such as their pro-consumption bias. He provides an Austrian analysis of financial markets, discussing the interrelations between the yield curve, interest rates, the discount rate, the structure of investment, the liquidity trap and the stock market. He analyzes real and nominal wages, business cycles, political implications, and intellectual predecessors of Keynes’s TGT using Austrian theory. Also very useful is Rallo’s guide for readers of TGT that makes reading and spotting Keynes’s main mistakes, chapter by chapter, easy and efficient. As a plus, at the end of the book, Rallo also provides a critique of the IS-LM model developed by John Hicks and Franco Modigliani which formalized Keynes’s theory and is still taught at universities around the world.
Rallo’s book on Keynes’s TGT is full of brilliant insights and provides the most powerful and complete case against Keynes currently available. The well-written Los Errores de la Vieja Economía will be the future reference for scholars and layman alike looking for errors in Keynes’s thinking and today’s policies. The main downside of the book is that it is written in Spanish. Hopefully, the work will be available in other languages soon.
“A formidable set of difficulties is encountered when we ask what there is left of the notion of monetary neutrality for a society which has once, for whatever reason, been thrown off the rails of steady advance, or for one which, like our own, has never really succeeded in adhering to them.
Does it… imply the maintenance of the situation existing at the moment, or the restoration of some previously existing situation, or the attainment of some situation never hitherto obtained?”
Sir Dennis Robertson, A Survey of Modern Monetary Controversy, 1937
“Mr. Harrod… pins his faith chiefly to a policy of government borrowing, initiated at the very onset of the recession, to finance both a carefully prepared plan of capital works and also if necessary the maintenance of consumption… so soon as the transition is effected, the borrowing policy is to be reversed. It is not easy to square this programme with the pessimism of Mr. Harrod’s central analysis and indeed in the end he admits that he feels bound to contemplate the possibility that the government debt may on balance continually increase.
After all, he consoles us, there are worse things than debt, alias the ownership of claims to income by poets and other worthy people; and fortunately it will be possible to combine the apotheosis of the rentier with his euthanasia”
Sir Dennis Robertson, Harrod: The Trade Cycle, 1937
Much to everyone’s relief – if to few people’s real surprise – the official Chinese numbers for the fourth quarter ‘improved’ from the previous trimesters’ mini-slough, with GDP accelerating from 7.4% yoy to 7.9% and industrial production ending the year at a 10.3% rate which was the fastest in nine months.
As usual, these data came with any number of attached caveats. Was it really possible, for example, that heavy industry grew at just under 10% in 2012 as a whole, while only using 3.8% more electrical power? Could this be done while rail freight actually dipped by 1.5% over the year or container traffic at the nation’s two biggest ports of Shanghai and Shenzhen only managed a combined 2.1% increase?
It does seem a touch problematical, doesn’t it?
Then again, what we do know – as we laid out in our last weekly edition [Material Evidence 13-01-25] – is that both fiscal outlays and credit provision grew markedly in the final quarter. Nevertheless, what we must look askance at is what supposedly resulted – the credibility-stretching 22% gain in profit and 15.6% jump in revenues (neither figure annualized) enjoyed by the SOE’s between the last three months of the year and the prior three. In yuan terms, we are asked to accept that QIV’s increment to revenues was the greatest on record; that to its profits, one not beaten since the first half of 2009 when the economy was roaring out of the post-Lehman slump.
What is also noticeable is that gross urban fixed asset investment for the year amounted to a massive Y34 trillion which, while computed on a different basis from the GFCF component of the number, represents a record high 70% of GDP. Moreover, the marginal extra UFAI undertaken in 2012 versus 2011 amounted to Y6.3 trillion (or +21%), which was a cool 136% of the Y4.9 trillion in declared extra nominal GDP (+9.8%), a surproportion only previously in evidence during the great reflation between June’09-June’10 – an episode to which much official hand-wringing has been devoted for having sown many of the troubles of misplaced investment and widespread peculation which so plagues the economy today.
Furthermore, the past twelve months’ cumulative CNY1.46 trillion positive trade balance was the largest since September 2009 and its YOY growth of CNY440 billion accounted for almost 10% of incremental GDP, the largest such contribution since 2007 despite the intent to focus henceforth on domestic, not foreign, sources of growth.
So, even if we take the Chinese numbers at face value (and all we have to say here is ‘Caterpillar’), the much vaunted ‘rebalancing’ would seem to have been postponed, once again, for reasons of short-term political expediency.
Any more confident analysis of China is being complicated by the fact that not only are the various institutions which comprise its leadership giving off conflicting signals – not least the obvious clash between the schedule of eye-wateringly expensive infrastructure schemes and the financial authorities’ moves to limit local governmental abuse of Off Balance Sheet platforms – but it is almost certain that we must wait until the formal handover of power in March for any major new policy initiatives to be given a more concrete form.
In the meanwhile, the market’s attention has been turned out past the Diaoyu/Senkaku islands towards a formerly slumbering Japan.
Not that the simmering territorial dispute is to be too lightly dismissed – not now we have Chinese militarists issuing nuclear-tipped warnings to the Australians not to run with the US ‘tiger’ or the hated Japanese ‘wolf’, or while Japanese foreign officials criss-cross the sea lanes seemingly intent on marshalling all of China’s fractious neighbours behind them – but the immediate focus has been the Bank of Japan’s capitulation to the Abe government’s threats to pack its governing council with Yes men and to rewrite the law defining its powers if it did not throw its weight behind the latest attempt to deprive the archipelago’s many pensioners – as well as its other purchasers of imported stuffs – of a living income.
Not that this is how the matter is being presented, of course, as the dark forces of global Keynesianism exult at the prospect of yet another New Deal being launched somewhere in the world. After all, it must be about time that oneof them actually ‘did what it said on the tin’ and restored prosperity by means of a clod-hopping bout of fiscal-monetary intervention to a people from whom it was taken by an earlier series of similarly ill-judged interventions from on high.
Given the already heated political situation in the region, the timing could be better, particularly with regard to a yen whose 10-week decline has only been exceeded (benignly) in the reversal of safe haven flows once the Lehman crisis began to abate and (less happily) during the Sakakibara episode in 1995 which arguably set the stage for the global instability of 1997-98. Already, Japan’s neighbours and export competitors – the equally growth-scarce Korea and Taiwan – have begun to make noises about the policy implications, while the Bundesbank’s Jens Weidmann has also expressed hopes that this does not mean a return to the dark days of competitive devaluation.
But, more fundamental than this is the very question of what the Bank and the LDP think they can achieve. Does the country really need any further, grandiose, state-financed spending programmes even if it could apparently bear to spend Y200 trillion (sic) on disaster-’toughening’ schemes, according to Abe advisor Satoshi Fujii? Can the country really be languishing so badly under the crushing burden of nominal interest rates which have barely inched above the giddy heights of 1% at the short end and 2.5% at the long these past fifteen years? Is the fall off in exports really either attributable to – or curable by – developments in the level of a real exchange rate which at its most unfavourable lay only 0.5 sigmas above its stationary, three-decade mean?
For now, the system has held together, with JGBs rallying under the same old QE rationale that has kept US yields from backing up in the face of yawning deficits. Given the presence of a non-price-sensitive buyer, wielding an inexhaustible cheque book, one would have to be truly foolhardy to short the bonds in one’s own currency though it is quite another matter if you come at them from abroad and later hope to spend the returns in your own, foreign domain.
It would not, however, be too wise for the authorities to flout the wishes of their long-suffering citizens, especially not when they have such a deep, vested interest in seeing neither their money, nor the banks and government debt which provide its backstop undermined. At a massive 115% of GDP, M1 money plays a bigger role in the economy than it does in most other developed nations (c.f., the ~50% in the Eurozone, or the ~20% which prevails in the US). As such, it makes up 55% of household financial assets and over 70% of financial net worth, with another 25% of the total exposed directly or otherwise to government debt.
For their part, banks hold over Y400 trillion in JGBs to back up their customers’ deposits, a total which is perhaps eight times larger than their equity capital (meaning a 180bp back up in 10-year yields would effectively wipe them out, if properly marked to market), while other financial institutions hold as much again. This is clearly not a country where one should knowingly tinker with people’s faith in either of these instruments – cash or bonds – in the pursuit of a serially failed and oft-vitiated nostrum.
Perhaps that is why the BOJ seems to have both postponed the onset of its Fed-like QEternity programme to 2014 and to have hedged about the wider terms of its abasement with a number of caveats. Even though it has committed to covering not just the deficit twice over this year, but actually the entirety of government outlays, its outgoing governor did publicise the valid objections of board members Kiuchi and Sato, while reserving to the Bank the right to ‘ascertain whether there is any significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances‘ and to attempt to hold the government to its pledge to ‘flexibly manage macroeconomic policy but also [to] formulate measures for strengthening competitiveness and [the] growth potential of Japan’s economy‘ while ensuring it will ‘steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management’.
Good luck with that, we would be tempted to say, but the more fundamental point is not whether we gaijin think (along with the likes of Kyle Bass) that all this must soon break apart, but rather when Japanese banks, Japanese insurers and pension providers and, above all, Japanese individuals lose faith in their own money. Here, we might note that they have been quiet net sellers of JGBs for a few quarters now, their actions only being offset by the increased absorption of the BOJ itself. One thing is for sure; the ‘end to deflation’ will not be a gentle or controllable affair, if and when it comes, nor will its impact be limited to Japan alone.
An Inflationist’s Charter
Beyond the fact that most of the biens pensants have uncritically accepted that Japan is finally ‘doing the right thing’ in acting in this manner and aside from the rather incongruous paranoia they nonetheless seem to share about whether perfidious Nippon will steal a march on them as the yen falls under the programme’s influence, renewed mutterings have emerged regarding the advisability of moving towards some form of NGDP targeting everywhere else within their purlieu.
Though there are a few rags of respectability to this concept, to most of those who espouse it these serve only to clothe the stark nakedness of what is, at root, yet another inflationary nostrum. After all, what is the point of being a member of the clerisy if you do not have some blinding wheeze to advocate as a means of extracting the world from its present mess without first having to face the reality that indebtedness is too high, capital has been misallocated on a grand scale, and that – by and large – we have all been seduced by both easy credit and the promise of unearned welfare into living just a little too much for the pleasures of the moment given the paltry gains concurrently being made in our real incomes.
The scanty raiments of reason associated with this canard are those which seek to limit fluctuations emanating from the monetary side of the economy not just by controlling an ‘M’ (upon whose exact composition, naturally, very few agree!) but also the rate at which it courses through the system (its ‘velocity’, if you must). Given that even the later Hayek mused aloud about whether this might not, in fact, be advisable (though most of those citing him conveniently forget to mention that he immediately went on to express grave doubts as to how exactly such a programme would be implemented), the idea has had a certain fatal allure even for those who generally would not endorse any more intrusive forms of monetary engineering.
But, even if we concede this point – arguendo – to the fractional free bankers, if to no others, the ugly truth is that the kind of automatic, bottom-up, self-governing mechanism which the likes of George Selgin argue their system would comprise is not at all what is being envisaged at present. Instead, the likes of incoming BOE governor Mark Carney – a man conveniently escaping the worst consequences of the bout of Dutch disease allied to a housing bubble to which his policies have contributed in his own land – do not just want to stabilize NGDP, but to target its growth AND, moreover to move it back towards the trend it was following before the Crash.
For example, in the US, the 1984-2008 log trend ran at around 5.5% p.a.: currently, we find ourselves some 15% below that trajectory trend, while growing at approximately 4% pa.
Ergo, to get back on trend in, say, three years’ time would require a growth spurt amounting to 45% – or almost 10% p.a. What sort of money growth do you suppose we are talking about to achieve THAT? And how much will arrive simply in the form of higher prices and not increased output, given that this is the sort of growth rate last seen in the Great Inflation of 1970-80?
For comparison, the UK faces a similar arithmetic, finding itself 16% below the pre-Crash trend and growing at less than half the prior pace, which means a 12% per year burst is needed, faster than was achieved during the booming 1980s when the RPI index ended up rising at a double digit rate. Then there is Europe. How are we to assure that the sorely-afflicted Latins reap the main benefit of any ECB largesse without blowing the still-affluent Teutons through the roof, especially given the fact that a three-year return to trend would have to double the pre-Lehman speed of increase?
Laying aside the question of what distortions and inducements to further capital wastage would occur were such at thing to be attempted on the necessary scale and quelling all doubts as to the advisability of even seeking to return to a trend which was artificially boosted by the nitro of the largest, arguably the most damaging, credit bubble in history, the very concept of NGDP suffers from problems of accuracy of measurement, representativeness, and timeliness.
NGDP under-represents the total flow of money in an economy by a good 50-60% by focusing only on the arbitrary Keynes-Kuznets final spending components and hence by ignoring activity in the more volatile, higher-order goods sectors whose smooth functioning are intrinsic to the very business of continued wealth creation and income generation.
Thus, even if we were to embark upon some semblance of this folly, the least we could do is to gauge our success with reference to the development of the more timely and accurate measurement of overall business revenues, not NGDP. Taking either sales themselves or, where not so readily available, an adjusted gross output measure as a proxy for these, it is also notable that the biggest present laggards in the US are to be found in residential construction, finance, non-food retail and – yes – government, while manufacturing has not only been growing faster than before the crash, but now lies only 4% or so below trend. Extractive industries are, of course, blazing the way forward as America’s energy revolution takes hold.
Thus, it could be argued that, however painful the process is for those who either work to a foreshortened, political timeframe or else who itch to earn some fleeting glory by ‘making the most of a good crisis’, the US is sluggish only in the areas which were responsible for the worst of the pre-crisis excess and conversely is doing pretty well, thank you, in the formerly neglected ones wherein tomorrow’s prosperity may be rebuilt. Pray tell how we are going to encourage this commendable re-orientation by lumping them all together and inflating the hell out of asset prices in order to make their aggregate rise more rapidly?
When Tomorrow Comes
In his recent allusion to this argument, there was a good deal of belated merit in what Raghuram Rajan had to say about why ‘stimulus has failed’. While it is always heartening to see one of the nomenklatura express such good sense in public, it never comes without a certain sense of frustration for, as readers of this publication will know only too well, we have been travelling – largely unaccompanied – this same road to Damascus for many a long year now.
That said, indulge us while we rehearse the main line of reasoning, once more, in the interests of clarity.
When large scale borrowing takes place beyond people’s ex-ante willingness to save (i.e., to abstain from complete, much less beyond-income, gratification), the builders and the buyers, the fabricators and the food shoppers will eventually find they are working at cross purposes and basing their (often unconscious) estimates of future income and outgo on premises which run into conflict with one another and to schedules which cannot be synchronized as they should.
Such borrowing may arise of its own volition – especially under the promise of a technological or territorial ‘New Era’ – but, ultimately, it must rest on the willingness of the commercial banks to create sufficient means to underpin it and they, in their turn, are no less dependent on the central bank and its regulatory peers committing sins of omission, if not of outright commission, in allowing such a pervasive and prolonged departure from the desirable norm as will eventually end in a general ruin.
Borrowing in this manner means that more are ‘bringing spending forward’ than are postponing it. Thus, as a group we end up anticipating and alienating too much of what is, after all, an uncertain future income stream in order to indulge ourselves today. Worse yet, this communal Rake’s Progress means that we are all but ensuring that our future income will indeed fall short of what it is we – and our lenders – expect when we mortgage so much of it to them in the present.
Activity of this kind is bad enough when the borrowing is mainly directed at over-consumption of ephemeral goods and services – whether by governments or by private individuals – but at least such a ‘simple’ inflation (to use the Austrian parlance) can be easily recognised for the evil it is and can be hardly less easily dealt with. In principle, the same should apply when the objects of desire are more durable, even if the dangers here are compounded (a) by the monetary authority’s reluctance to countenance any action to prevent the rise in such politically-sensitive things as house prices and (b) by the high loan-income ratio and higher loan-to-value leverage often extended upon what always seem such sturdy forms of collateral.
In contrast, when the borrowing is devoted to building out industrial capacity – when it represents ‘cyclical’ inflation, as we would say – the scope for error becomes much larger even as it is insidiously less apparent. This is because the market for the planned new output lies not only further out into an unknowable future which is very unlikely to reflect the current pretensions of even the most confident of prognosticators, but because that market is only indirectly linked to the final consumer and is therefore all the more highly contingent upon the actions of others – whether suppliers, customers, competitors, providers of complementary goods, and users of similar resources, not to mention regulators, politicians, and warlords.
Again, while the problems increase the ‘higher’ such an enterprise lies ‘up’ the productive structure, away from the ultimate storefront, it is often here that the longest and largest financial commitments must be made, making the receipt of any false signals, in the form of overeasy credit conditions and overbouyant equity markets, not only more decisive as to its to its inception, but all the more perditious once ground has actually been broken.
When ‘tomorrow’ finally comes – as it progressively, day by day, must do – we are then all too apt to find that increasingly onerous degree of debt service to which we have blithely been contracting leaves us too little left over to spend on the consumables so called into being, meaning that the scale and composition of the capital stock laid down when we earlier availed ourselves of all that temptingly easy money can not hope to find a retrospective justification.
One way or other, a recognition must now be made of the magnitude of our error and if not blame, at least responsibility, must be apportioned where it is due; losses must be realised; and titles transferred as quickly as possible not only in order to make a fresh start at the earliest possible juncture – one which will ipso facto be based on a much more sober reckoning of our wants and means – but so that the effort to escape or to procrastinate does not itself forge a chain with which to weigh us further down. Write-offs and write-downs are much more salutary and far less invidious than the determined application of transfer politics by the horde of economically-illiterate careerists who populate the chambers of the legislature.
At this point, we are poorer than we assumed we would be and we may even be absolutely poorer than we were before we strayed off the path of intertemporal co-ordination which is illuminated by the beacons of self-regulating, time preference-determined ‘natural’ interest rates. Though it may seem callous to call now for a ‘liquidation’ of our mistakes, it is the attempt to camouflage this wherein the most pressing dangers lie. The so-called ‘secondary depression’ which are told to avoid at all costs is one thing (and it is still not proven that, only assuming a core quantity of money supply is assured, Pigou – or ‘real balance’ – effects will not cause this to blow itself out so long as prices are sufficiently flexible downwards in the slump to increase that unshrunken kernel’s overall purchasing power), but the progressive petrification of the whole spirit of free enterprise which is its alleged preventative is quite another.
Pricing out Recovery
Alongside the clamour for more monetary monkey business, much lip service is also being paid to the need for ‘structural reform’ and, in the Austrian sense of increasing responsiveness and removing barriers to initiative – what Fritz Machlup called an ‘Auflockerung’ – this is indeed a necessity. But this is not something which will be enacted by governments eager to extend corporate welfare to failed Wall St. Banks, uncompetitive French car companies, needlessly duplicated Chinese steel manufacturers and the like. Nor are they and their central banking friends likely to aid the requisite process of ‘recalculation’ – of working out what one should pay for something today and what one is likely to get for it or the things fashioned from it, tomorrow if interest rates are being falsified, taxation is volatile (upwards, at least), and exchange rates are subject to sudden wrenching shifts.
At bottom, to be coherent, interest rates should correspond to the price ratio between present and future goods and the eagle-eyed entrepreneur is the man who can recognise an arbitrageable disparity between the two in specific instances and hence can put something which is currently being undervalued to a better, alternative use. But, if he judges the spread between current inputs and his expected, risk-adjusted output is too narrow to be worth his effort, he will not be willing to provide an income to those selling the first, or employment to those who might otherwise make a living by transforming them under his guidance into the second.
Yet much of the thrust of today’s rabid Rooseveltianism is conspiring to keep this critical spread overly compressed and entrepreneurs understandably coy to embark upon major new undertakings.
- Raw inputs cost too much because of easy money, ZIRP storage arbitrage, green rent-seeking, and welfare-subsidized consumption
- Labour remains expensive due to dole-encouraged withholding and the high ancillary costs imposed by an overweening and unaffordable state apparatus
- Expected returns on capital – outside of those to be gained by gaming the capital markets, that is – are depressed by the anti-capitalist thrust of taxation and the regulatory and legal flux to which entrepreneurs are being subjected to an unnecessarily elevated degree
- The prospective flow of sales receipts is also being diluted by the presence of so much state- and bank-supported, sub-marginal deadwood in the market.
One of the features of a slump in which can be found the seeds of a subsequent regeneration is that the inputs to a more sustainable and inherently profitable production process can be had cheaply. To this end the irrational fear of the bogeyman of ‘deflation’ is itself the root cause of the process by which the aptitude for change and the appetite for risk can become quasi-permanently suppressed.
Bankruptcy breaks up unviable capital combinations and frees up willing workers for the business of founding new industries and of identifying and satisfying new tastes, a point that Ludwig Lachmann was every ready to extol. ‘Capital’ is a concept; it is a dynamic, it is not an inert, physical lump of easily-stilled mechanisms. In the right hands, yesterday’s failed crop can become the fertilizer of tomorrow’s harvest as long as its owners are encouraged to realize their losses and to sell it on to those with a better vision of how to utilize it at a price commensurate with the new endeavour’s chances of success.
Sadly beguiled by their own theoretical cleverness, those setting policy today are so fixated on the idea of forcing people to buy things just to be rid of the excess money which is being forced upon them and so dead set against anything actually costing less than it used to, no matter how ludicrous the previous valuation or how commercially wrong-headed the purpose to which it was being dedicated, that their own efforts at ‘stimulus’ are forestalling this act of revaluation and release – this recapitalization of the decapitalized – and so are turning them instead into the greatest mass sedative ever prescribed to the mercantile classes.
The Big Freeze
In our Austrian narrative of a ‘cyclical’ inflation, fiduciary (unsaved) credit is preferentially funnelled towards investment in new capacity and expanded business. This soon leads to an unlooked-for degree of competition for resources with the earners of increased wages who are mostly still unsated in their demand for the existing array of consumables, items which the expansionists are either not planning to provide just yet, if at all. Such a conflict of desire can only end up in widespread over-extension; in the appearance of large quantities of ‘frozen’ capital; and hence in disappointed creditors and investors amid a general disco-ordination of plans.
In contrast to such an overheated condition, much of today’s unsaved credit is being directed at ensuring that zombie companies can display the barest signs of animation so as to enable their bankers to justify the ‘evergreening’ of their loans. Working on a cash basis, possibly too unprofitable to pay tax, certainly not amortizing their debt and probably bleeding capital by eating into their depreciation allowances, such ICU-institutions do little more than clutter up their lenders’ balance sheets, cling on to experienced and diligent staff, occupy prime property, burn electricity, and buy in stock – and so deny their more vibrant, self-reliant counterparts, whose innate abilities are greater but who have to operate on a fully commercial basis, the room and the means to grow.
Every great efflorescence of life, every great evolutionary advance in the long and violent history of dear old Mother Earth has come in the wake of a mass extinction. Without the Alvarez meteorite, after all, we hairless apes would probably not be here to debate the finer points of how our policies are only serving to maintain the economic dinosaurs in command of their niche, far beyond their natural span.
Making matters worse, the remainder of the credit inflation is being monopolised by incontinent states and their skulk of rent-seeking jackals, elites whose intrinsic capital efficiencies are vanishingly small (if not actually negative) and whose activities are therefore particularly likely to contribute to capital consumption.
Here we are faced with the awful irony that, in their manful attempt to lighten the load of indebtedness, central banks are helping generate ever more debt. Whereas the money they are creating is supposed to be a final means of settlement which extinguishes debt at the completion of a contracted period of service, it is instead giving rise to more of that which must, one day, be settled. Hence the source of that widely-shared and intensely pernicious confusion of what are static accounting identities in the macro reports with the dynamic process of economic life. We do not need someone else to borrow in our place if we choose to pay down our debts: if we sell without buying in order to discharge our obligations, our satisfied creditor now has both the wherewithal and the available wares to buy in our stead. Even if we find, alas, that we cannot fulfil our contract, to substitute another claim for it by transferring it to some larger, less constrained entity such as the state is to fall for a sunk cost fallacy. We took and used the present goods over which command was given us by our lender and we turned out not to be able to replace them: thus they are irrevocably lost, no matter what anyone cares to scribble in the pages of their accounting ledger.
Unable as we are to see this, we will continue to invest in negative productivity and purposely to select against the fittest. Instead of a classic Austrian overheating, we now have an Ice Age: instead of a credit bubble, we have a debt black hole.
Just as in Japan, we have transferred private actor difficulties into public sector ones where no legal framework exists to resolve the resulting problems. Worse than this, we now face a classic ‘public choice’ trap, to introduce the concept elucidated by the late, great James Buchanan.
Once we decide to move private liabilities onto the public balance sheet instead of swiftly excising them in the crisis, not only are the protocols for later resolution sorely lacking, but the incentives are almost entirely absent, too. Being ‘public’ debts which no individual entity can be said to have incurred, there is too diffuse a sense of responsibility for them – if not an outright tragedy of the commons. Since there are no identifiable culprits for the evils they entrain, outside the hated ‘capitalist’ caricatures of popular invective, it is all too easy for the economic illiterates in parliament to pretend that they were in no way responsible for the debt the incoming regime has inherited (even if often in great part from its own former time in office).
Wedded to the state’s arbitrary ability to impose financing charges on third parties (and the fact that pressure-group politics will see the regime’s court favourites and swing voters militate not to bear any concentration of this cost) is the fact it runs completely counter to political ambition to say “we will do less - less intervention, less spending, less feather-bedding – than the losers you just ejected”.
Given a further boost by the almost universal faith in half-fdigested Keynesian nostrums (exemplified perhaps by the recent apoptheosis of the dreadful old Leftie patriarch, Robert Skidelsky), we are about to discover that by saving the banks, we are destroying the pension and insurance companies upon whom the average man is no less reliant. As a result, many of our present day states are fast approaching the limits of budget credibility and so have no choice but to resort more and more to seigniorage in order to survive. Some would, indeed, already have exhausted that reservoir, too, were it not that such infernal devices as TARGET2 allow them to draw heavily upon the reputation and good-standing of their neighbours.
That this policy has not yet led to a resurgence of old-fashioned, shopping-basket price rises (even if, in contrast, its malign, if seductive, effect on asset prices is not to be denied) is largely down to luck.
An increase in the supply of money leads to higher prices only to the extent its recipients’ desire to hold it does not increase in due proportion. What we have seen in the past four years is that, largely, it has. Firstly, higher degrees of credit have lost much of their superficial sheen of ‘moneyness’ since the collapse, meaning that the parties to an exchange are now far less willing to rely upon the ready negotiability and unquestioned fungibility of lesser IOUs as a means of settlement than they were during the boom. Secondly, the banks themselves have not been able to throw off so many of their more dubious accommodations into the ask-no-questions-tell-no-lies underworld of a now-moribund ABS market. Adding to the squeeze, as we have already set out, they have encumbered their balance sheets with a host of low-grade borrowers at the same time that both regulatory capital requirements and wholesale market funding possibilities have become a good deal less conducive to blind expansion than they were in the Blue Sky days of yore. Thus, a greater proportion of a money supply which is having to ‘do more work’ than has been the norm is being generated ‘outside’ the commercial banks rather than ‘inside’ them – i.e., by the central banks through their vastly expanded range of operations.
This, too, is a case of lowest common denominator lending, since what these central banks prefer to monetize above all is government (and quasi-government) debt. In this way they are temporarily satisfying people’s heightened need for money by removing the worst constraints from those closet Jacobins who, we have argued above, are the very people obstructing the process of recuperation and regeneration.
With a nod to the ideas of Axel Leijonhufvud, what this also may imply is that the income-constrained recipients of welfare (personal or corporate) are the agents least likely to cling on to any of their dole, while the still-healthy who receive it at one remove are fast becoming Ricardian equivalence hoarders – knowing, as they do, that, as the only obviously identifiable sources of wealth and with very little patronage to shield them, Leviathan will soon come ravening after them. So, with the associated opportunity costs eradicated by the central banks’ flawed attempts at stimulus, they are clutching tight to their caches of sterile silver ahead of the day when they fear they must render it up wholesale to an aggressively insistent Caesar.
Beyond the Impasse
Thus we have the paradox that, on the one hand, we must be grateful that the central banks are finding too few takers for the snake oil of inflation to do its corrosive work because the supposed solution it offers is not only arbitrary and dishonest, but because it also confounds accounting and so destroys capital and wastes further resources – progressively the moreso, the more rapid and variable its rate of propagation. That it also tends to favour the least savoury elements of society (i.e., the plutocrats and the politically-protected), means that any stay of execution is further to be welcomed on moral, as well as on material, grounds.
On the other hand, the maintenance of ZIRP – and its extension across the maturity spectrum is doing little to help and much to harm. Some say it counter-intuitively promotes saving as those who still can set more current income aside to make up for the lowered returns they receive on their nest eggs. If only this were so, for even though this is something the mainstream perversely insists on decrying, it is actually the wellspring of our well-being. Your author, however, doubts it does much to promote saving in any productive sense: instead it serves to keep capital locked up in dead undertakings and so slowly bleeds the rest of us dry, therefore destroying real savings, not adding to them and continuing the recession, not curtailing it.
At some point, this dangerous impasse will have to be resolved, either in an admission that macroeconomic means have failed and that renaissance must at last be sought – as we have long argued – in providing a more conducive microeconomic milieu (an epiphany which will be a long time coming since it implies the headlong retreat of the Provider State militant) or, alas, in a ‘flight to real values’ and a conflagration of financial claims to wealth amid the rubble of a monetary collapse.
But perhaps we must not be too hasty in calling for the turning point to arrive. Japanese experience teaches us that the stand-off can be maintained for nigh-on a generation if the benefits of slow price declines (not ‘deflation’, please) become widely recognised and if people further accept that if the state is to subsume their unserviceable private debt contracts while not taxing the skin from their backs in order to do so, they must volunteer to surrender up a good part of their income to it by continually adding to their holdings of its obligations (both dated – JGBs – and perpetual – currency). Of course, it helps if the people in question are both productive and thrifty enough to have no need for external finance and possess a high home-bias in their investments and so are not overly susceptible to sudden reversals of sentiment on the part of the hot-money crowd.
As for the rest of us – who are not necessarily endowed with such commendable attributes of forbearance – whether we further resist it or no, everything points to the conclusion that the Mighty Ozzes at the central banks have not yet lost their will for the struggle and that the creeping ‘euthanasia of the rentier’ and ‘monetary policy à outrance’ will be further prosecuted, no matter how high the cost or how exiguous the results.
Such is the curse of the Platonic arrogance of our masters and their willing enablers.
Not your typical Cobden Centre interview, but hopefully thought-provoking …
John Llewellyn is one of the most highly regarded economists in Europe, having worked in the private sector, academia, and national and supranational policy institutions. He now runs his own consultancy, advising governments, multinational corporations, and institutional and private investors. He was educated in the neo-Keynesian tradition but, on becoming an applied economist, he became what he terms “an evidence-based eclectic”. As such John recognises the potential explanatory limitations of the Keynesian paradigm for a world of excessive debt and unprecedented policy activism. At present, he is concerned about what appears to be an unfolding, synchronised global cyclical downturn amidst what remains a structurally weak growth environment. The consensus is in his view too complacent in believing that recent policy stimulus actions will either lift growth rates or reduce debt burdens meaningfully over the coming 1-2 years.
BY WAY OF BACKGROUND…
Born in England, but raised in New Zealand, John Llewellyn attended The Victoria University of Wellington for his BA (Hons) degree and then Oxford University, where he obtained his DPhil. He then researched and taught at Cambridge University for nearly ten years, and was a Fellow of St John’s College. Thereafter, he moved to Paris to the Organisation for Economic Cooperation and Development (OECD), the supranational economic policy analysis and forecasting organisation, where he rose from Head of Economic Forecasting to Deputy Director for Employment, and finally Chef de Cabinet to the Secretary General. In 1995 he moved to London, where he was Global Chief Economist for Lehman Brothers until 2005, when he became the firm’s Senior Economic Policy Adviser. Following the bankruptcy of Lehman Brothers he set up his own firm in 2009, Llewellyn Consulting, which specialises in thematic macro research (e.g. demographics, technological innovation, climate change) and economic risk assessment.
I came to know John during my time at Lehman Brothers in the mid-2000s, where I was the European Head of Interest Rate Strategy. We worked closely together to link economic forecasts and risks with practical, implementable strategies for the global interest rate and currency markets.
We both became deeply concerned by developments in global housing and credit markets in the mid-2000s, in particular in the US, agreeing that a dangerous bubble was forming in association with global trade and capital flow imbalances. On numerous occasions we presented our counterparts and other colleagues in New York with this view. It was not well received.
When the crisis began to unfold in 2007, and then intensified in 2008, neither of us was particularly
surprised. We did not, however, predict that not only Lehman Brothers but also a number of major financial institutions would fail. The intensity of the crisis and the aftermath of tepid growth, together with lingering structural problems and global imbalances, have caused both of us, each in our own way, to change the way we think about the world, and question some core assumptions. In general, this process has led us to become decidedly less optimistic in how we see the economic future.
John and I continue to speak on a weekly basis, and get together at least once a month to review global economic developments and assess the risks, as we see them. Recently, John identified an associated set of economic risks that could well result in a much sharper downturn in global growth over the coming year than the consensus expects. What follows below is a rough amalgamation of several informal, recent conversations between us about how John came to this view; about the risks associated with excessive debts and so-called ‘financial repression’; the future of the euro and possible alternatives to the current set of national economic policy choices. The conversation then turns to the financial markets.
THE GATHERING STORM
JB: John, in your most recent economic risks publication, you write that, in 2013, economic activity in nearly every part of the world is likely to slow. That is highly unusual. Normally there are at least a few pockets of strength that support demand for weaker economies. If that is not going to be the case, does this raise the risk of a generally sharper downturn across the world?
JL: It does. Conventional, single-economy, economic models assume stable and reasonably large fiscal ￼and monetary multipliers. These are derived from historical observation. But there is little evidence about synchronised global downturns, so most of the data are irrelevant, or at least potentially misleading: policymakers are therefore likely to underestimate the size of the coming slowdown. This analytic point used to be one of the major reasons for, and messages from, the OECD; but the message is heard less these days. Were the US, the EU, or China to get traction with new stimulus in the near-term, then the slowdown would be less likely to be synchronised, and the consensus, as best I can tell, would be more likely to be correct that 2013 growth will be similar to 2012. On the other hand, if there is a further move toward outright tightening of policy, say due to the fiscal cliff in the US, or enhanced austerity in Europe, things could get worse.
JB: Let’s step back for a moment. Neither the fiscal cliff nor austerity would be an issue if debt burdens were lower, or growth higher, or both. Manageable debts are a nonissue. How did the developed world get into this mess? Is it purely a result of the financial crisis, or were there longer-term, structural forces at work, largely unseen by the policy mainstream?
JL: To some extent the answer differs from country to country. Some, like Greece and Portugal, were simply consuming beyond their means, and had to rein in total expenditure. Others, like Spain and Ireland, as well as the UK and the US, let leverage in their financial systems build up to such an extent that, when assets prices collapsed, the authorities had little option but, in effect, to nationalise the resulting private sector debt in order to keep the financial system functioning. But overlaying this in virtually all economies was, and is, a set of promises made by generations of politicians that they will be unable to meet, not least given the ageing of populations.
JB: Doesn’t this bring a central tenet of Keynesian economics into doubt, that you can borrow your way to prosperity? While countercyclical government borrowing and spending seems reasonable on paper, we now have quite a bit of empirical evidence that these debt burdens accumulate over time, that governments embrace deficit spending but eschew the offsetting surpluses required to keep finances in balance. Going forward, should we have faith that policy can be more responsible?
JL: The central tenet of Keynesianism is subtler than the bastardised version that came to be taught later. I was taught what I would term ‘classical Keynesianism’ in New Zealand, and had it reinforced at Cambridge by former colleagues of Keynes, such as Joan Robinson, Austin Robinson, Richard Kahn, Nicholas Kaldor, as well as more recent luminaries, such as Geoff Harcourt and John Eatwell. This central tenet is that borrowing works if it takes GDP back towards full employment, and fairly quickly, and if it kindles, or re-kindles, Keynes’ ‘animal spirits’ – the entrepreneur’s intrinsic faith such that he or she is willing to incur the certain cost of borrowing now in the expectation that he or she will earn a return in an unavoidably uncertain future. In other words, as Robin Matthews pointed out in the 1960s, Keynesianism works only if people believe it will work. Or, as Keynes observed, economies are held up by their own bootstraps.
FINANCIAL REPRESSION PAST, PRESENT AND FUTURE
JB: Returning to the fix we appear to be in, I know you have thought extensively about policies that limit financial freedom in order to subsidise government debt service and reduction, collectively termed in the jargon as ‘financial repression’. Could you elaborate on this and how you see it developing going forward?
JL: Basically in such circumstances, governments do four things: they encourage inflation; they instruct the central bank to keep short rates and bond yields along the curve low; they oblige savers (including pension companies and insurance companies) to hold an increased proportion of their assets in government bonds; and they impose capital controls to prevent savers from taking their capital abroad in search of higher real yields.
JB: But does it work? Recall that Carmen Reinhart made explicit that ‘financial repression’ is historically associated with failing third-world governments desperate for public revenue. What does this imply about the developed world today? Are you troubled by this? Does it not seem, potentially, to be a road to ‘financial tyranny’? A road to Argentina, to name an obvious case in point?
JL: It does work; but of course it is troubling. The West has used these policies before. The UK, the US, and France amongst others did exactly what I have summarised to reduce public debt as a proportion of GDP after WWII. But there was a difference then: As various people of that generation have told me, they were completely aware at the time that the war bonds that they were buying would not be worth much, if anything, after the War. But they bought them nevertheless, because that was the price for having a chance to defeat tyranny. I am not sure that the younger generation will be so tolerant today with politicians and political parties who made promises only to get elected, and which they knew they could not fulfil.
PRESENT AT THE CREATION
JB: You were, to use a colloquial term, present at the creation of the euro. You knew some of the architects. You observed, indeed contributed to, some of the planning, as well as the implementation. And now you have observed the crisis unfolding. You have always held that the euro is a political project, and remains so. You are also on record as having more confidence than most that the euro will not only survive but that it will in time prove its detractors wrong, that it will enhance European economic performance through greater stability and integration.
￼Given recent developments, this seems a bold view to some. Would you care to elaborate?
JL: All economists involved in the creation of the euro knew that its initial institutional arrangements contained a number of important flaws. But those ‘present at the creation’ also knew that Chancellor Kohl and President Mitterrand knew this too. The Kohl / Mitterrand calculation was that they were the last generation fully able to appreciate the enormity of war in Europe; that they would bind their two economies together by ‘a thousand silken threads’; and that they would hope that when, in the future, the project ran into problems, their successors would choose to fix them rather than allow the union to break up. So far, the gamble has paid off. Of course, the British do not see it that way. They were told by Edward Heath that this was an economic union, and they believed him. And British economists in turn analyse the union purely in economic terms. That is a generalisation: but you get the point.
JB: You also hold, and rightly so I believe, that there is far too much focus on the troubles of the euro-area and not enough on those elsewhere. As a case in point, consider Japan, which has comparatively larger demographic issues with which to deal and which is, following a multi-decade period of sub-par growth, slipping out of trade surplus and into deficit. In my opinion, this is an issue not only for Japan but for the entire world. How do you feel about Japan?
JL: Under US guidance, Japan did a brilliant job after WWII in adapting its manufacturing sector to the Western (initially US) market which the US opened to it, and then widened further by admitting Japan to the OECD. But Japan’s policymakers drew a wrong conclusion: That the only way to grow was to sell goods to foreigners. As a result they never allowed any real competition, nor any structural reform, to take place in the service sector: They did not realise that they could get rich also by selling to themselves. To this day, they have not learned that lesson.
JB: It is so easy to forget that no single economy is a closed system. Especially today, given how globalised the world has become. Even the US, which has a comparatively small external sector, is today far more widely integrated into the global economy that it has ever been. There is also the non-trivial matter of the US providing the world’s reserve currency. Some argue that this ‘exorbitant privilege’, to use a term coined by former French President Valery Giscard d’Estaing, is not at risk. I know you disagree that the US is a ‘safe-haven’ in the way normally portrayed in the financial press. Could you please elaborate?
JL: A country is a safe haven right up until the moment when investors decide that it is not. The US economy produces a vast array of goods and services. If since WWII one had to hold monetary assets denominated in any currency, that currency would be the US dollar. Dollars can be converted into anything that one might conceivably want. But alternatives are emerging: The euro. The renminbi. At the least, investors will want to diversify; and indeed they are so doing. And if the US does not deal with its fiscal problem, the move away from the dollar will likely accelerate.
JB: But that is precisely the point: The US is not a safe haven. A safe haven cannot be a country that is at risk of devaluation, default, or some combination of the two. But that does leave a rather small list of countries, and I would suggest that none of them is realistically the provider of a dominant reserve currency, or the provider of sufficient additional aggregate demand to provide for Keynesian stimulus to bail the world out of its excessive debts. If this is the road we’re on, where does it lead? Can the economics profession continue to act as if the policy tools and actions that got us into this mess can get us out? Or does the solution lie elsewhere?
JL: Just as reflating one’s own economy requires that entrepreneurs and investors have faith in the future, so does reflating the world economy require that entrepreneurs and investors have faith in the currency or currencies that are attempting the reflating. I shudder to think what the world economy will look like of investors’ faith in the dollar declines, rather than revives.
FROM DEBT CRISES TO CURRENCY CRISES
JB: When a debt crisis becomes a currency crisis you have a problem that is an order of magnitude greater, because at that point you are not only distorting macro price signals via ‘financial repression’ but as there is now so little confidence in the stability of the currency, and households and businesses no longer have confidence in their ability to manage their time preferences effectively. Austrian economists would argue that this is so damaging that, if sustained, it will destroy an economy’s capital stock through severe resource misallocation. Do you have some sympathy with this view or is it too pessimistic?
JL: I have some sympathy, but also some humility. When economies are so far away from where they have even been in modern economic history; when the structure of our economies, with their much, much larger government sectors, is so unprecedented; and when we have been told so confidently what will happen by economists who engage in a priori theorising only to be proved wrong later, I am, I confess, rather more humble.
JB: The alternative to printing your way out of a debt burden is to allow for bankruptcy, restructuring and reorganisation of the capital stock to take place instead. Josef Schumpeter called this ‘creative destruction’, and he believed that it was not only helpful but in fact essential for economic progress. Might a severe recession be exactly the bitter medicine required at this point to save the patient, rather than more of the palliative to date that appears not to be working, or perhaps even making the problems worse? Would you argue that Britain’s ￼basket case economy of the 1970s could only have been turned around in this way? Or could there have been a more mainstream, Keynesian way to go about it, such as an even larger currency devaluation?
JL: I have never liked ‘severe recession’ as the cure for anything. The spectre of all that lost output always appalls me. It smacks of the same mentality that advocated bloodletting and leeches. It has always seemed to me that more useful things could be done with potential output than just letting it flow out to sea. The state could build toll roads, harbours, airports, even certain types of housing, and sell them off later to the private sector when confidence returned. Surely that ought to be possible.
JB: Let’s move a bit closer to your current home. What about the UK of today? Does the UK need to undergo another Thatcher-like experience, something beyond timid ‘austerity’, including more meaningful structural reforms to make it more competitive internationally in exports? If so, would that be easier to accomplish were the UK to leave the EU? You have said that there is a distinct possibility of that in the coming few years.
JL: I think that leaving the EU is a distraction from the real issue, which is that UK companies are sitting on a pile of cash and are so uncertain about the future that they will not invest. Meanwhile households are trying to reduce their borrowing; and so is the government. The only thing to be done, in my view, would have been for the government to have undertaken the type of investment that companies otherwise would have done, and sell it on later. But that idea ran straight up against political dogma.
JB: But if the UK economy needs to rebalance, doesn’t the US need to as well? And on the other side of these trade deficits are trade surpluses elsewhere. Can the world continue to grow without first correcting these imbalances to at least some degree? And doesn’t history suggest that imbalances this large are ultimately corrected only in periods of unusually weak growth?
JL: Here you are putting your finger on a problem that Keynes highlighted at the end of WWII, but which Harry Dexter White, the senior US Treasury official at the 1944 Bretton Woods conference, refused to acknowledge. Surpluses and deficits are mirror images of one another. Two sides of the same coin. There cannot be one without the other. Hence being in surplus is just as contributory to imbalances as being in deficit. In a properly run global world, policies would bear down on surplus economies and deficit economies equally. But they never do.
ON FINANCIAL MARKET VALUATIONS AND THE MONETARY FUTURE
JB: Taking into account our discussion so far, I think there are ample reasons why the stock market should appear ‘undervalued’ to many. P/E ratios may not be particularly high, even if profit margins are. The fact is, however, revenues simply cannot grow rapidly in this environment, at least not in real terms. And record profit margins cannot survive a proper global rebalancing as the cheap labour of emerging markets converges on the developed world. In my opinion, given the structural macroeconomic headwinds we have discussed, stock market valuations should, in fact, be at generational lows, perhaps below where they were in the early 1980s or early 1960s. Your thoughts?
JL: I think that that argument is correct as far as it goes. But given that investors are starting to lose confidence in paper assets, and particularly government paper, they want to hold something real: and that includes shares in companies. And it is not as if there is a stock market bubble – so far at least. PEs in the US and the UK are not far from their historical averages.
JB: But if stock market valuations need to adjust even lower from here, perhaps much lower if policymakers don’t embrace more meaningful structural reforms, and if bond markets are overvalued due to the risks of currency devaluations, where, exactly, is an investor to hide? I lean toward a diversified exposure to real assets, including raw commodities. Could you perhaps share your thoughts on that?
JL: Clearly, commodities, industrial, food, and of course gold, are obvious contenders.
JB: Speaking of gold, you are aware that I believe that there has now been so much global economic confidence lost that it will not be properly restored absent a return to some form of gold standard, if only for international rather than domestic commerce. While I know you are sceptical, you don’t disregard the idea entirely. You have mentioned before the possibility of an international pricing convention based on a ‘bancor’, a currency based on a fixed basket price of globally traded commodities. How might that work? And are you confident that there would be sufficient support for such a regime, given that global economic cooperation is endangered by the threat of competitive devaluation, trade wars and the rise of economic nationalism generally?
JL: It would work by governments setting fixed rates for converting currencies into a basket of commodities. I think that it makes logical sense; and it could help in spurring the production of commodities that would later be in demand as activity picked up. Kaldor thought a lot about this, and we discussed it when I worked under him. But equally, I am sure that it is a non-starter. Two decades of life in the OECD has shown me just how hard it is for countries to agree about anything so fundamental.
JB: Some economists simply dismiss the idea of a gold standard as archaic and unworkable. I don’t think you hold that strong an opinion. But what would you see as the primary disadvantages of a gold standard, or relative advantages of the current dollar reserve standard. Does it come down to how much confidence you have in policymakers?
￼JL: It is possible to have confidence in individual policymakers at the national level, while nevertheless having little confidence about their ability to agree to reforms to the international system as a whole. And that is where I come from. In any international negotiation of this sort, two types of country have disproportionate influence: the biggest; and those in current account surplus. Today, that would mean the US and China: and I doubt that they would agree on any reform that proved to be in the global interest.
IF JOHN WERE IN CHARGE
JB: Now I’m really going to put you on the spot. An economist of your stature must always be considered a potential candidate for a senior policy role, say as a senior advisor to a finance minister, or a member of a central bank policy committee. Were you to be appointed to a role in which you had a broad mandate to design and implement fiscal and monetary policy, say for the euro-area or the UK, what would you do? If hard choices need to be made and if you had the mandate to make them, what would these be?
JL: In the UK, about which I thought particularly as an adviser to the Treasury from 2009 to 2012, I would have “thrown everything at the 2008 crisis, including the kitchen sink” as my friend William Keegan put it and as, in fact, Alistair Darling did. And I would thereafter have set out on much the same course of fiscal consolidation as Darling did, and Osborne continued. I think that Paul Krugman and Ed Balls understate the risk that would attach to the government borrowing substantially more. But, as I indicated above, I would also have embarked on finding ways to support private-sector-like investment. My proposition throughout has been that the government should have been willing to underwrite, or undertake, investment that produces marketable output – ports; airports; toll roads; certain types of housing, etc. These could be valued and entered as an explicit, verifiable, line in the National Accounts, and could later be sold to the private sector. The ratings agencies would, on my understanding, have been open to such a plan being explained to them.
JB: I’m pleased to hear that there are things that might yet be done within the existing policy framework to help, at least if people listen to you a bit more! Thanks so much for your time; I’m certain that Amphora Report readers will appreciate it.
JL: Thank you John.
JB: Perhaps we can do this again in a year or so to see how things are panning out?
JL: It would be my pleasure. Perhaps you will even eventually win our bet that Greece withdraws from the euro-area.
JB: Well as you recall that bet expires on 31 December. It appears I will need to treat you to dinner in the New Year.
JL: Ah yes. Well as you strategists sometimes say, all views are potentially correct; the timing, however, is always uncertain.
JB: Indeed. Well Happy Holidays!
JL: To you too John.
POST-SCRIPT: FROM RISK TO UNCERTAINTY
My many conversations with John, including those recent ones merged into the transcript above, were an important input into my 2012 Amphora Reports. While the primary purpose of these reports is to interpret contemporary economic and financial market developments through the lens of Austrian economics (and occasional, plain common sense), it is essential to continuously check assumptions, however strongly held. As I’m certain is clear from the conversation(s) above, John has provided an invaluable source of such checking.
This is not to say that we agree on most things. Far from it. For example, as alluded to briefly in closing, I am of the opinion that the euro-area cannot survive in its current form. John believes that it is indeed salvageable, although he does doubt the willingness of policymakers to do what is necessary.
This brings us, I believe, to the crux of the risks the lie ahead. Policymaker activism continues to escalate across economies. This is not going to change in the near-term, nor absent another crisis that clearly and plainly discredits economic central planning generally, be it in fiscal or monetary matters. As has increasingly been the case in recent years, future risks are going to originate primarily from policy decisions. They will, in other words, be qualitative rather than quantitative in nature.
This article was previously published in The Amphora Report, Vol 3, 09 January 2013.
Recently, someone left a comment on a post here along the lines of: “What’s your problem with Keynes?” One of the replies mentioned Hazlitt’s The Failure of the New Economics which is a critique of Keynes’s General Theory.
As that very book had been gathering dust on my bookshelves for a number of years I thought it was about time I actually read it. So, I did.
And, what did I learn? Sadly, not much. I learnt that Hazlitt writes well but I knew that already. Economics in One Lesson is a masterpiece. And he is on form here too. His put downs of Keynes are tremendous fun:
I have been unable to find in it a single important doctrine that is both true and original. What is original in the book is not true; and what is true is not original. (p6)
So I have found in Keynes’s General Theory an incredible number of fallacies, inconsistencies, vaguenesses, shifting definitions and usages of words, and plain errors of fact. (p7)
One reason Keynes’s thought is so often difficult to follow…, is that he writes so badly…. And one reason he writes so badly… is that he is constantly introducing technical terms that are not only unnecessary but inappropriate and misleading. (p16)
One begins to suspect that Keynes’ reputation, like Shaw’s, rests in large part on sheer impudence. (p346)
Keynes’s trick in this chapter is to mix plausible statements with implausible statements (p173)
The theory embodied in this paragraph is that the public is irrational, that it can be easily gulled, and that the object of government is to be the chief party to the swindle. (p245)
And so on.
But I was left with a problem. Hazlitt’s criticisms may be witty and elegant but are they true? I didn’t have the time to go through the whole of Keynes’s General Theory to check but I could at least have a stab at one chapter and see if it Hazlitt’s criticisms stand up. Does Keynes say what Hazlitt says he says? And is Hazlitt’s analysis correct? I took as the sample chapter the one on the Multiplier.
Sadly, this experiment didn’t work. Keynes is so opaque – even arch-Keynesian Paul Krugman admits it’s “tough meat” – that, try as I might, I couldn’t understand it. All I can say is that Hazlitt’s description appears to be correct. The idea that there is a causal relationship between current marginal investment and current marginal incomes appears to be absurd. To say that this relationship can be used to increase incomes seems doubly absurd.
At this point some wise words from Brian Micklethwait kicked in: if you can’t understand it that’s their problem, not yours. It is up to Keynes (or his supporters) (and for that matter Mises and his) to make me understand what they are on about. I will make moderate efforts and no more.
Of course, we are assuming that there is such a thing as “Keynesianism” to understand. One of Hazlitt’s complaints is that he is constantly changing his definitions and contradicting himself. I, myself, am aware that having described gold as a “barbarous relic”, Keynes went on to support its being part of the monetary system, before condemning it in the General theory and then supporting it again as part of Bretton Woods.
Now, people do change their minds over time. I am sure there are differences in Mises’s thinking between The Theory of Money and Credit and Human Action but I suspect they are not that great – certainly nothing like as great as Keynes’s.
Still, I feel obliged to give Keynes one last chance. If the theory can’t help us what about the practice? I grew up in Britain at a time when Keynesian policies were being practised red in tooth and claw. They didn’t work. On two occasions – the early 1980s and the early 1990s – semi-Austrian policies were followed. They did work. I am not aware of any time or any place where Keynesian policies have worked and I am not aware of any time or any place where freedom (to give Austrianism its real name) – even in a watered-down form – did not.
As an aside I’ll allow Paul Krugman to have the final word. This is what he had to say in an introduction to the General Theory in 2006:
One can identify a number of occasions, most notably Japan in the 1990s, where depression-like conditions might well have returned without the guidance of Keynesian economics.
Words fail me.
As 2012 draws to a close, we should note that it is the 50th anniversary of the 1962 publication of Murray Rothbard’s grand treatise, Man, Economy, and State. This was the book that inspired many of today’s “Austrian” economists to devote their careers to this unorthodox but remarkable school of thought. In this essay I’ll first explain who Rothbard was, and then summarize some of the major elements of his treatise.
Murray Rothbard (1926-1995) became interested in laissez-faire economics at a relatively young age. While working on his economics Ph.D. at Columbia University, Rothbard attended Ludwig von Mises’ famous seminar at nearby New York University. According to this biographical essay, Rothbard
made major contributions to economics, history, political philosophy, and legal theory. He developed and extended the Austrian economics of Ludwig von Mises…He…applied Austrian analysis to historical topics such as the Great Depression of 1929 and the history of American banking.
Rothbard was no ivory-tower scholar, interested only in academic controversies. Quite the contrary, he combined Austrian economics with a fervent commitment to individual liberty. He developed a unique synthesis that combined themes from nineteenth-century American individualists such as Lysander Spooner and Benjamin Tucker with Austrian economics. A new political philosophy was the result, and Rothbard devoted his remarkable intellectual energy, over a period of some forty-five years, to developing and promoting his style of libertarianism. In doing so, he became a major American public intellectual.
Although Rothbard would eventually write several books—any one of which would have secured his legacy to economic theory and the political philosophy of liberty—his magnum opus was Man, Economy, and State, to which I now turn.
Style and Scope
Rothbard originally intended his work to be a textbook treatment of Ludwig von Mises’ own magnum opus, Human Action, which had come out in 1949. Indeed, Herbert C. Cornuelle, president of the Volker Fund, was the one to pitch this idea to Rothbard that very year. Rothbard prepared an outline and a sample chapter on money, then received the blessing of Mises himself to go forward with it.
However, as Joseph Stromberg chronicles in exquisite detail in his Introduction to the Mises Institute’s (2004) Scholar’s Edition of MES, upon embarking on the project Rothbard eventually realized that a mere textbook would not be adequate. Cornuelle had visited Rothbard and asked if he thought the work should become a treatise in its own right. Rothbard pondered the question and eventually wrote in response (in February 1954):
The original concept of this project was as a step-by-step, spelled out version of Mises’ Human Action. However, as I have been proceeding, the necessary elaborations on the sometimes sparse framework of Mises has led inevitably to new and original presentations. Now that I have been proceeding to the theory of production where the whole cost-curve situation has to be faced, Mises is not much of a guide in this area. It is an area which encompasses a large part of present-day textbooks, and therefore must be met, in one way or another….A further complication has arisen. A textbook, traditionally, is supposed to simply present already-received doctrine in a clear, step-by-step manner. But not only would my textbook fly in the face of the doctrine as received by 99 percent of present-day economists, but there is one particularly vital point on which Mises, and all other economists, will have to be revised: monopoly theory.
Thus we see that Rothbard eventually realized that he was writing a brand new treatise, resting on the Misesian edifice to be sure, but one that was Rothbard’s own. Not only did Rothbard differ from Mises on certain key points (some of which will be discussed below), but even where their treatments were compatible, Rothbard’s was the clearer and more systematic.
The fundamental difference between Human Action and Man, Economy, and State is that the latter, though intimidating because of its size, is completely self-contained. The intelligent layperson with no prior exposure to any economics can read just Rothbard’s treatise, and walk away understanding the core of orthodox Austrian theory. In contrast, Mises’ classic work assumes a great deal of background knowledge on the part of the reader, including Kantian philosophy, the classical theory of value, and Böhm-Bawerkian capital and interest theory (!). None of this is meant to belittle Mises’ work, but merely to underscore that I personally always point the dedicated newcomer to MES first, and only then to Human Action.
A “Misesian” Work Grounded in Praxeology
Rothbard begins the book closely following in Mises’ footsteps, by categorizing economics as a subset of praxeology, which is the science of human action. According to Rothbard, starting from the basic axiom that human beings act—in other words, that they consciously use means to (attempt to) achieve desired goals—one can logically deduce the entire body of economic principles or laws.
It is interesting to read Rothbard’s description (in a March 1951 letter to Cornuelle) of his method of attack:
What I have in mind for a textbook would be a pioneering project….At each step, the reader would be enlightened through simple, hypothetical examples, until, slowly but relentlessly, he would find himself equipped to tackle the economic problems of the day….[T]hrough this method, even the most confirmed socialist, would step-by-step, beginning with simple praxeological axioms, at the end, suddenly find himself realizing the absurdity of his socialist and interventionist beliefs. He would become a libertarian in spite of himself.
Following Mises, Rothbard and his modern disciples argue that sound economic theory is logically antecedent to empirical investigation. If trying to understand the causes of the Great Depression, for example, one can’t simply “let the facts speak for themselves,” because there are an infinity of possible facts one could assemble for the purpose. (What was the mass of the moon on February 16, 1923, at exactly noon GMT, and might it have something to do with the 1929 stock market crash?) Indeed, the very concepts of money, interest rates, and so forth are themselves theory-laden; one needs to have a praxeological foundation in order to even perceive such categories, because they don’t exist “out there” in “the real world” the way a naïve positivist might suggest.
The Structure of Production
Joe Salerno once told Rothbard that he (Rothbard) had incorporated the capital theory of Böhm-Bawerk into his exposition far more than Mises had done in his own works. For those of us who read MES in our youth, we take this for granted, but Salerno’s observation is perfectly correct: Rothbard takes the crucial yet at times mind-numbingly dry treatments of Austrian capital theory from the masters (mainly Menger, Böhm-Bawerk, and Hayek) and distills them into a very readable discussion. He caps it all off with a beautiful diagram (appearing in the beginning of Chapter 6, “Production: The Rate of Interest and Its Determination”) that I have described as the superior Austrian version of the mainstream’s “Circular Flow Diagram.”
Rothbard’s diagram takes the famous Hayekian triangle and rotates it 90 degrees to the right, so that what is considered the earliest or “highest” stage of production, actually is the highest bar on the diagram. At each step moving downward, the goods-in-process have moved through another period of work, where further inputs of land, labor, and capital goods have been applied, transforming the capital goods to become ever closer to the ultimate consumer goods.
Rothbard’s ingenious construction allows for an “economy-wide” accounting, where the capitalists earn the correct rate of return on their investments each period, and where the net incomes earned by the capitalists, land owners, and laborers each period sum to the total spent on the finished consumer goods emerging from the bottom of the production “pipeline” that period.
Throughout the book, Rothbard makes original contributions, but they are often in the form of making a received point a little more crisply, or by filling in a gap in the standard case for a familiar conclusion. When it comes to monopoly theory, however, Rothbard overturns the tables and starts from scratch.
Rothbard begins his treatment by challenging the very notion of “consumers’ sovereignty” as developed by William Hutt. Hutt (and later Mises) used the term to convey the notion that the “customer is always right,” and that through their spending decisions the consumers in a market economy ultimately allocated resources to competing ends.
Rothbard rejected the term on the grounds of both accuracy and strategy. Strictly speaking, it was simply not true to say that consumers were somehow “sovereign” over producers. Yes, consumers were free to withhold their money, but by the same token business owners were free to withhold their products, and workers were free to withhold their labor. Instead of exhibiting consumers’ sovereignty, Rothbard felt the free market demonstrated individual self-sovereignty.
Rothbard also disliked the term for strategic reasons, because the notion of “consumers’ sovereignty” could be used as an ideal benchmark with which to criticize the performance of the real-world market. Indeed, that is precisely what happened (with the related notion of “perfect competition”) in mainstream welfare economics.
During his preliminary discussion of monopoly, Rothbard makes some brilliant observations. For example, he points out that most economists and the general public are horrified by the formation of a cartel, while they look with favor upon the creation of a corporation. Yet the processes are quite similar, involving individuals pooling their resources into a unified enterprise. Rothbard also generalizes Mises’ calculation argument as originally applied to a socialist State, to show that no single firm could ever encompass the entire economy.
In another tour de force, Rothbard shows the dangers of the mainstream fascination with graphical expositions. It is standard in textbooks to this day to show the inefficiencies of “monopolistic competition” using a diagram where the downward sloping demand curve is tangent to the U-shaped average cost curve on its left side, which is not at the lowest point on the curve. Mainstream economists attribute to this purely geometric result economic significance, claiming that “monopolistically competitive” industries will have “excess capacity” and operate at higher unit costs than a perfectly competitive industry. Yet Rothbard points out that this result follows purely from the convenient assumption of a smooth U-shaped average cost curve. If instead we used a jagged average cost curve (with straight lines connecting discrete points), then a downward sloping demand curve could cross the AC “curve” at its lowest point. In other words, Rothbard showed, the standard textbook critique of industries such as sneakers and breakfast cereals, was based on a graphing decision and had little to do with economic analysis.
After these warm-up sections, Rothbard goes for the throat: He denies the very existence of a so-called “competitive price,” with which to contrast the allegedly inefficient “monopoly price.” Instead Rothbard offers the free-market price, which is the only benchmark that can be discussed coherently.
Critique of Keynesianism
In addition to his positive exposition of sound Austrian economics, Rothbard fills MES with critiques of rival doctrines. I am particularly fond of his discussion of Keynesian economics. The critiques have lost some of their force over the decades, because a typical Keynesian textbook no longer motivates its policy conclusions with the arguments that were common when Rothbard was writing. Even so, Rothbard’s demonstrations are a joy to behold.
My personal favorite is his reductio ad absurdum of the multiplier (based on a similar argument by Hazlitt). After reviewing (what was at that time) the standard Keynesian case that new investment spending will have a “multiplier” impact on total income, Rothbard uses the same approach to “prove” that the reader of his book has a much higher multiplier still.
Specifically, Rothbard sets out a few equations, showing that “Social Income” is equal to the “Income of the Reader” plus the “Income of everyone else.” Then he uses some empirical observation to discover that the “Income of everyone else” is 0.99999 times “Social Income.” After some algebra, Rothbard concludes that “Social Income” is 100,000 times the “Income of the Reader.” The consistent Keynesian, Rothbard notes, should then advocate that the government print up dollars and hand them to the reader of Rothbard’s book, because the “reader’s spending will prime the pump of a 100,000-fold increase in the national income.”
Fifty years after its initial publication, Murray Rothbard’s grand treatise still holds up. I have written a Study Guide for it, and still receive emails monthly from people thanking me for helping them work through this classic book, because they recognize its importance and the knowledge it contains. If anyone considers him or herself a fan of Austrian economics and has yet to try Man, Economy, and State, I promise you are in for a treat.
This essay is based on an article originally published by in The Freeman.
The Japanese government for the last twenty three years has employed the Keynesian tools of deficit spending and more recently the monetarist policies of expanding money supply in an attempt to stop the economy from sliding into recession and to develop some growth. On paper, it has only achieved the former objective; in reality it has emasculated the productive capability of her domestic economy.
Before the speculative bubble of the late-1980s the Japanese economy was driven by savings. Her strong savings flow gave Japanese industry access to a stable low-cost source of real capital with which it was able to produce high-quality goods for export at competitive prices. While there was, in the free market sense, much wrong with Japan this characteristic more than compensated for her economic sins. However, the bubble came along, fuelled by the institutional greed of the Zaibatsu which through their banks sanctioned a spectacular expansion of credit, and as bubbles go this one went pop spectacularly. Since then the government has done everything it can to stop banks folding and industrial malinvestments from being liquidated.
The result is an economy which has barely progressed since. Japanese investment in manufacturing has been directed elsewhere, particularly other South-east Asian states and China. So the result of deficit spending has been a mountain of public sector debt with no domestic economic progress to show for it. Now that government debt-to-GDP is at 240%, or over one quadrillion yen, Japan is resorting to accelerated money-printing as the only and final solution.
This will destroy her currency; and Japan also has another problem with its aging population. Those savers of yesteryear are now drawing down on their nest-eggs at an accelerating rate. This means the genuine capital for Japanese industry to use for industrial investment is no longer there. The switch from accumulating savings to savings drawdown is also beginning to be reflected in the Japanese trade figures. They are now moving into deficit, a reflection of the change from net private-sector saving accumulation, to net private sector consumption.
This is bound to lead to a growing pool of yen in weak foreign hands, and a need for the government to import capital to cover its deficit. No longer is Japan self-financing. This implies that interest rates will have to rise, but think of the cost for the world’s most indebted nation.
There is little new in my analysis, and it should certainly come as no surprise. Her detractors have cited Japan’s deteriorating age demographics for at least the last decade, and it has been obvious to the markets that Keynesian and monetarist solutions have made no positive difference. After all, the Nikkei Index is still bumping along at about a quarter of its December 1989 peak. The economy has simply been in a prolonged slump.
The difference today is the move towards a trade deficit, which will put increasing amounts of yen into weak foreign hands. For this reason 2013 is likely to be the year when the accumulation of government deficits and the ramping-up of money supply between them finally undermine the yen.
This article was previously published at GoldMoney.com.