Editor’s note: this article, under the title “No end to central bank meddling as ECB embraces ‘quantitative easing’, faulty logic” appears on Detlev Schlichter’s site. It is reprinted with kind permission.
The 2nd edition of his excellent Paper Money Collapse is available for pre-order.
“Who can print money, will print money” is how my friend Patrick Barron put it succinctly the other day. This adage is worth remembering particularly for those periods when central bankers occasionally take the foot off the gas, either because they genuinely believe they solved the problem, or because they want to make a show of appearing careful and measured.
The US Federal Reserve is a case in point. Last year the Fed announced that it was beginning to ‘taper’, that is, carefully reduce its debt monetization program (‘quantitative easing’, QE), and this policy, now enacted, is widely considered the beginning of policy normalization and part of an ‘exit strategy’. But as Jim Rickards pointed out, the Fed already fully tapered twice – after QE1 and after QE2 – only to feel obliged to ‘qe’ again some time later. Whether Ms Yellen is going to see the present ‘taper’ through to its conclusion and whether the whole project will in future be remembered as an ‘exit strategy’ remains to be seen.
So far none of the big central banks has achieved the ‘exit’ despite occasional noises to the contrary. Since the start of the financial crisis in the summer of 2007, the global trend has been in one direction and one direction only: From easy money we moved to easier money. QE has been followed by more QE. As I mentioned before, the Fed’s most generous year in its 100-year history was 2013, any talk of ‘tapering’ notwithstanding.
ECB mistrusted by Keynesian consensus
Whenever the European Central Bank reduces its money printing and scales back its market rigging, it invariably unleashes the fury of the Keynesian and inflationist commentariat. In the eyes of its numerous critics, the ECB lacks the proper money-printing credentials of the more pro-active and allegedly more ‘modern’ central banks. It still has a whiff of the old Bundesbank about it, although a few years back, when the ECB flooded the European banking system with cheap liquidity, its balance sheet was larger as a share of GDP than those of its comrades, the Fed and the Bank of England.
The ECB went through two periods of restraint since the crisis: In early 2011 it began to hike interest rates, and in 2013, after the eurozone debt crisis died down, the ECB allowed its balance sheet to shrink by more than €700 billion as banks repaid cheap loans from the central bank. This stood in stark contrast to the Fed’s balance sheet expansion of about $1,000 billion over the same period. The first episode of restraint came to an end in 2012 when the ECB reversed its rate hikes and then cut rates further, ultimately to a new low of just 0.25 percent. Presently, we are still in the second period of restraint, although it too appears to be about to end soon as the ECB’s boss Mario Draghi hinted in his press conference last week at a newfound willingness to embrace unconventional policies to combat ‘deflation’ or even ‘long periods of low inflation’. (The ECB’s harmonized index of consumer prices stood probably at just 0.5% last month.) This means the ECB is likely to cut rates to zero or below soon, or to start asset purchases (‘QE’), or probably both.
This move is hardly surprising in the big scheme of things as outlined above, and the ECB will explain it officially with its mandate to keep inflation below but close to 2 percent, from which it does not want to deviate in either direction. This target itself is silly as it assumes that inflation of 1.8 percent is inherently better than inflation of zero (true price stability, if it ever was attainable), or inflation of minus 1.8 percent (deflation). This is, of course, precisely the argument that has been relentlessly and noisily trumpeted by the easy-money advocates in the media, the likes of Martin Wolf and Wolfgang Münchau in the Financial Times, and the reliably shrill Ambrose Evans-Pritchard in The Daily Telegraph, among others. A certain measure of inflation is deemed good, very low inflation is bad, and anything below zero, even mild deflation, potentially a disaster. But why should this be the case?
Moderate deflation, that is, slowly declining money prices, may or may not be a symptom of problems elsewhere in the economy, but that slowly declining money prices as such constitute an economic problem lacks any foundation in economics and can easily and quickly be refuted by even a cursory look at economic history. In the 19th century we find extended periods of ongoing, moderate deflation in many economies that simultaneously experienced solid growth in output and substantial rises in living standards, a “coincidence”, wrote Milton Friedman and Anna Schwartz in their influential A Monetary History of the United States, 1867 – 1960, that “casts serious doubts on the validity of the now widely held view that secular price deflation and rapid economic growth are incompatible.”
Many commentators advance the argument that falling prices depress consumption as purchases get constantly deferred. Even the usually more sober FT-writer John Authers seems to have succumbed to this argument as he explained to his readers last Saturday that prices “fall, thanks to sluggish economic activity. Consumers do not buy now, as goods will be cheaper in future. This lack of consumption slows growth further, and pushes prices down even further.” (John Authers, “Draghi has to back his QE words with action” Financial Times, Saturday April 5/ Sunday April 6 2014, page 24)
This argument, constantly regurgitated by the cheerleaders of money-printing, is weak. First of all, it is certainly no argument in the present environment of close to zero but still positive inflation. If the ECB plans to fight even very low inflation, as Draghi stated at the ECB press conference, than this argument does nothing to support that policy. Certainly, no one defers any purchases when prices are just stable. However, and more importantly, even in a mildly deflationary environment of let’s say 1 to 2 percent per annum, the argument does appear to be a stretch.
Argument ignores time preference
Consumers only contemplate buying something that they consider an economic good, that is, that they consider useful, that they want because it expends some (subjective) use-value to them. In deferring a purchase they can, in a deflationary environment, save money but at the cost of not enjoying the possession of what they want for some time. By not buying a toaster now you may be able to buy it 1 or 2 percent cheaper in a year’s time, or 2 to 4 percent cheaper in two years’ time (always assuming, of course, that the mild deflation persists that long, which nobody can guarantee), but even these small monetary gains come at the expense of not enjoying ownership of the toaster for two years. The small monetary gain obtained by delaying purchases is not for free, as the argument seems to assume, but comes at the cost of waiting. I suggest that only a very small number of items, and only those for which there is very marginal demand indeed, would be affected.
Time preference is not a concept of psychology, it is a constituting element of human action. It is a priori to human action, which means it exists independent of experience or of personal circumstances as it is already entailed in the very concept of what constitutes an ‘economic good’.
If you experienced no time preference in relation to a specific good you would be indifferent as to whether you enjoyed the possession of that good today or tomorrow. And tomorrow you would be indifferent as to whether you enjoyed it that day or the next, and so forth. Logically, you would be indifferent as to whether you enjoyed possession of it at all, and this means that the good in question is not an economic good for you. You do not care for it.
As George Reisman put is succinctly: To want something means, all else being equal, to want it sooner rather than later.
Be honest, how many purchases over the past 12 months would you not have made had you had a reasonable chance of obtaining the item in question at a 1 or 2 percent discount if you waited a year?
That the prospect of falling prices does not usually deter consumption can be readily seen today in the market for consumer electronics (mobile phones, computers), which has been in deflation – and considerable deflation – for quite some time.
Argument ignores opportunity costs of holding money
The argument also seems to ignore that holding one’s wealth in the form of money involves opportunity costs. Rather than sitting on cash you could enjoy the things you could buy with it. In a deflationary environment, your cash hoard’s purchasing power slowly rises and you can afford ever more nice things with your money, which means the opportunity cost of not spending it constantly goes up. (In a way, while you are waiting four years to buy your toaster at an 8 percent discount to today’s price, buying the toaster is also becoming marginally more attractive to others who are presently holding cash and who may initially not even had an interest in a toaster.)
I think that all that would follow from secular (that is ongoing, systematic but moderate) deflation is that cash would be a more meaningful competitor for other depositories of deferred consumption. Saving by simply holding money makes sense in a deflationary environment, so other vehicles to save with (bonds and shares) would have to offer a return reasonably above the expected deflation rate to attract savings. I think this is not an unreasonably high hurdle.
Furthermore, if what Authers and others describe were true for even marginal deflation, that is, if marginal deflation indeed led to more deflation and a progressively weakening economy, the reverse must logically be true for marginal inflation. Consumers would accelerate their purchases to avoid the 1 or 2 percent loss in purchasing power per annum, and this would quickly drive inflation higher. If two percent deflation led to cash hoarding and a collapse in consumption, would the 2 percent inflation advocated today as ‘price stability’ not lead to a spike in money velocity and an inflationary boom? Either scenario seems highly unrealistic.
Monetary causes versus non-monetary causes
If we use the economic terminology correctly, then inflation and deflation are always monetary phenomena, that is, they always have monetary causes. (As an aside, I here use the now standard definition of inflation as an ongoing, trending rise in the general price level, and deflation as the opposite, rather than the traditional meaning of inflation as an expansion of the money supply and deflation as a contraction.) However, the starting point of the present discussion is simply some low readings on the official inflation statistics in the eurozone. And that those could have non-monetary causes, that they could be the consequence of a crisis-driven drop in real demand in certain industries and certain countries is a realistic assumption and is in fact implied by the arguments of the QE-advocates. Outright deflation is presently being recorded in Greece, Cyprus, and Spain. And John Authers’ short statement on deflation in the FT also starts from the assumption that “prices fall thanks to sluggish economic activity.”
But to the extent that recorded deflation is not due to a general rise in money’s purchasing power (due to a general rise in money demand or an unchanged or falling money supply, to which I come soon) but the result of some producers slashing certain prices in certain industries and regions, and of those price drops not being fully compensated by rising prices somewhere else in eurozone, then this has various implications:
Consumers cannot simply assume that this is a lasting trend. The liquidation of capital misallocations and the discounting of merchandise to get it moving are crisis phenomena and cannot simply be extrapolated into the future the way consumers may have extrapolated the secular deflation of gold standard economies in the 19th century. But the straight extrapolation of very recent price changes into the future is at the core of the argument that even small deflation would be disastrous.
Furthermore, it would seem bizarre to advice merchants to not slash prices when demand drops as that would, according to the logic advanced by Authers et al, only lead to further postponement of consumption and a further drop in demand as consumers would simply expect price declines to continue. Would hiking prices be a better strategy to counter falling demand? Should we reconsider the concept of the “sale” and of “discounting” inventory to encourage buying?
To a considerable degree, the reduction in certain prices for ‘real’ economic reasons could be part of the economic healing process. It is a way for many producers, sectors of the economy, and economic regions, to regain competitiveness. It is true that falling wages in certain industries or regions make it more difficult for workers to repay mortgages and consumer loans but often the lower wage may be the only way to avoid unemployment, which would make repaying debt harder still. Behind the often-quoted headline inflation rate of presently 0.5% per annum lie numerous relative price changes by which the economy re-balances. All discussions about the ‘price index’ ignore these all-important changes in relative prices. It so happens that what goes on with the multitude of individual prices in the economy adds up, according to the techniques of the ECB statisticians, to a 0.5% harmonized inflation rate at the moment, and it may all add up to -0.5% next month or next year, or maybe even – 1 percent. To simply conclude from this one aggregate price number that the economy is getting progressively sicker would be wrong.
There is no escaping the fact that recent economic difficulties are the result of imbalances that accumulated during the credit boom that preceded the 2007/2008 financial crisis, of which the eurozone debt crisis was an after quake. Artificially cheap money created the credit boom and these imbalances. A period of liquidation, contraction, changing relative prices and occasionally falling prices is now necessary, and short-circuiting this process via renewed central bank intervention seems counterproductive and ultimately dangerous.
There is, of course, the possibility that proper monetary causes are behind the eurozone’s low inflation and soon deflation, and that those might persist. Banks still feel constrained in their ability to extend new loans and thus create new money. The growth in bank lending and thus in wider monetary aggregates may fall short of the growth in money demand. But it is an essential feature of money that any demand for it can be fully satisfied with a rise in its price. Demand for money is always demand for readily exercisable purchasing power, and by allowing the market to lift the purchasing power of money, that is, through deflation, that demand can be met. The secular, moderate and largely harmless deflation of 19th century gold standard economies had essentially the same origin. Money production did not keep pace with money demand, so money demand was satisfied via slowly falling prices.
And here the same conclusion applies: a more restrained approach to lending, credit risk, and financial leverage, now adopted by banks and the public at large as a consequence of the crisis, may be a good thing, and for the central bank to mess with this process and to use ‘unconventional’ means to force more bank lending and money creation onto the system, out of some misguided commitment to the arbitrarily chosen statistical goal of ‘2-percent inflation’ seems foolish. If successful in raising the headline inflation rate it may succeed in creating the same imbalances (excessive leverage, misallocations of capital and distorted asset prices) that have created the recent crisis.
One commentator recently said the eurozone could ill afford deflation considering the size of its bloated banking sector. But the question is if it can afford the level of lending to attain 2 percent inflation considering the size of its bloated banking sector.
The fallacy of macroeconomics and macroeconomic policy
Let me be clear: I do not recommend a zero-inflation target or a target of moderate deflation. Moderate deflation in and of itself is a little a solution as moderate inflation in and of itself is a problem. I recommend no target as I reject the entire concept of ‘monetary policy’, of the notion that a state agency could conceivably enhance, through clever manipulation of interest rates and bank reserve policy, the coordinating powers of the market that help people realize their personal economic objectives through free trade.
We should remember that no one participates in the economy and in trade and commerce because his or her goal is that the general price level goes up by 2 percent, or that nominal GDP increases by 5 percent. People have their own personal objectives. The market is simply a powerful tool for voluntary and decentralized plan-coordination among independent individuals and groups of individuals that pursue their own goals. It is best left undisturbed. This entire project of ‘monetary policy’ is absurd in the extreme, regardless of what the target is.
It is the fallacy of macroeconomics that certain statistical aggregates, such as CPI, GDP or nominal GDP, are deemed reliable representatives of what goes on in a complex market economy, and it is dangerous hubris to believe that the state should define ‘targets’ for these statistical aggregates and then use policy intervention to achieve them. This might be an approach intellectually suitable for the ruler of a communist or fascist society. It is fundamentally at odds with free trade and a free market, and it must and will fail. That should have been a clear lesson from the financial crisis.
Instead, the mainstream consensus, deeply influenced by Keynesianism and macroeconomics, continues to embrace policy activism and intervention. I fully expect central banks to continue on their path towards more aggressive meddling and generous fiat money production. It won’t take long for the ECB to take the next step.
Steve Baker has written an article for today’s City A.M. calling for an end to the ‘cruel delusion of cheap money and reckless spending‘:
George Osborne will present his Autumn Statement to a country in the grip of a cruel economic delusion, perpetrated against the poor and the aspirational.
Welfare states everywhere are spending chronically beyond their means while papering over the cracks with easy money. Budget 2013 forecast spending in excess of receipts of about £9bn a month. Defence, criminal justice, local government and the Foreign Office have been squeezed. Two thirds of spending was expected on health, education and welfare, mostly pensions.
The sick and disabled, families, children and pensioners are reliant on these crucial services. With taxes already too high, government is critically funded by the bond markets. Those bond markets are in a dangerous bubble, deliberately inflated by central banks.
Keynesian economists prescribe even more stimulus to dreadfully-mistaken applause, as if it were in the general interest to expand the state yet further and borrow to do it. They should be more honest about their politics. It’s true the Budget isn’t like that of a household or business, because the government can tax, intervene and create money. That’s just the problem: state power is a great force for destruction …
Read the whole article.
Since our last attempt at a textual analysis of where the economic pain threshold lies for China’s rulers, the intervening period has been punctuated by a flurry of meetings, pronouncements, prognostications, and policy precursors.
The net result? That anxieties are certainly rising; that there are some signs of intense political manoeuvring; but that Xi and Li have so far largely stuck to their guns.
Taking the politics first, two items stand out: the news that court proceedings will shortly commence against the disgraced Bo Xilai – wherein he will face charges mostly relating to corruption and the abuse of power – and the post-dated report of a meeting with Henry Kissinger at which former President and éminence grise, Jiang Zemin, fully endorsed the policies of his successor-but-one.
The timing of the first seems nicely calculated to neutralize critics on the left of the party and to preclude any haggling over Bo’s fate from taking place at the upcoming Beidaihe party summit, thus leaving the agenda free to thrash out the nitty-gritty of economic policy ahead of the crucial autumn Plenum.
The second, by contrast, seems to rule out any open, factional divide between pro- and anti-reformers and, taken with Xi’s subsequent re-iteration of his call to ‘deepen reform and opening up’, provides another re-run of the manner in which Deng Xiaoping outflanked Jiang himself on his famous ‘Southern Tour’ of 1992 (an event symbolically commemorated by Xi on his scene-setting first excursion from Beijing after being sworn in as General Secretary in December).
On that earlier occasion, Deng ringingly declared to the back-sliders who were threatening to unravel his grand designs that ‘whoever does not support reforms should step down’ – an implied threat whose resonance will surely not be lost on any of today’s doubters.
Categorizing this as a ‘strategic decision’, last week Xi urged ‘a spirit of reform and innovation’ and for the Party to display ‘ever more political courage and wisdom.’
‘China must break the barriers from entrenched interest groups to further free up social productivity and invigorate creativity,’ he went on. ‘There is no way out if we stay still or head backward.’
Again, the official press coverage of Tuesday’s Politburo meeting was replete with the usual litany regarding fine-tuning, prudent monetary policy, fiscal adjustment, greater efficiency, scientific developments, etc., etc. But, again it emphasized that macro policy should be stable (read my lips: ‘no – monster – stimulus’) and micro policies should be active.
Along these lines, Premier Li had already unveiled a mini-package which sought to ease taxes on SMEs, to expedite the formalities associated with the export trade, and to move up consideration of further railway construction out in the under-developed Wild West of the country. But, far from a reversion to type, this was seemingly so underwhelming that since he announced this, the prices of the likes of steel, coal, aluminium, and copper have severally resumed their slide.
Even the resort to fiscal policy seems to envisage a refreshingly different approach, coming as it does with an avowed intent to limit the budget deficit and reduce spending while alleviating the tax burden where possible. Is this a hint that Beijing will pursue a proper, stimulatory austerity of less government on both sides of the ledger in place of the deadening ‘fauxterity’ of less rapidly increasing outlays mixed with swingeing tax rises currently being practiced in the West? One would certainly like to think so.
Taken with the diktat which aims to address at least some of the worst heavy incidences of industrial over-capacity (a move said to be ‘key to restructuring’ in Xi’s own emphasis), the buzzword for policy seems to be what Li termed ‘sustained release’ – i.e., that there will be no big, blockbuster launches if indiscriminate lending or spending, but instead a steady drumbeat of hopefully therapeutic micro-measures.
On top of that, there was an intriguing reference to the idea of ‘enhancing a sense of urgency’ which was closely linked to the vow ‘to firmly grasp the opportunity for major enhancements’. Does this mean that Xi and Li are cleverly playing the anxieties of the moment in order to lessen resistance to their program of change? That through a strategy of masterly inactivity they will first disabuse the hordes of disobedient local cadres and SOE oligarchs of the presumption that they are all Too Big To Fail, leaving them no option but to adapt to the new policy thrust as the only alternative road to promotion and self-enrichment? It would certainly be nice to think so.
Along these lines, it surely cannot be a coincidence that the press has been filled with cautionary tales deriving from the bankruptcy just declared by Detroit. Nor that a veritable army of 80,000 audit officials is being mustered to go out and assess the true level of local government indebtedness across all levels from the smallest township to the largest central city. The result cannot fail to be chastening even if it is deemed not to reach the CNY20-25 trillion which lies at the top end of some estimates. No doubt there will be sufficient violations of central policy, accounting practice, and banking regulation, not to mention outright criminality for the tally to give Xi and Li a powerful means of seeing that their wishes will henceforth be complied with.
Before we leave this issue, there is one broader point which we must make: namely, that this thoughtlessly regurgitated idea that what China needs is more ‘consumption’ and less ‘saving’ is nothing more than yet another dangerous Keynesian canard.
What the country needs – what any country needs – is more consumer satisfaction, agreed! But how this is to be most sustainably (not to mention most equitably) achieved is to ensure that the greatest possible fraction of production is geared to that end above all others. It should then be obvious that this is an endeavour that cannot fail to require investment: rationally-undertaken, market-oriented, ex ante, private savings-funded, entrepreneurially-directed investment of a kind that has been all too lacking in China, perhaps, but investment all the same – and a good deal of it, too, in a country where the average person suffers a standard of living still far below what could so easily be his to enjoy.
So, firstly, let’s be honest and reclassify all the sub-marginal, no-return-on-capital, ‘empty-asset’ ‘investment’ as what it really is – state-led CONSUMPTION and we will at once clear up a good deal of semantic confusion and hence lessen our chance of chasing off down the wrong macro-aggregate pathway.
China’s personal consumption may well be depressed below its potential – though the fact that households appear to save around a quarter of their income is not wholly exceptional in fast-developing countries, for how else is the growth to be funded? No, the real crux of the matter is that China’s collective consumption (largely undertaken by soft-budget SOE’s and deficit-junkie governments) is far too high and so thoroughly lacking in genuine prospective return to be further borne. It should therefore be no part of policy to increase blindly the degree of exhaustive consumption – especially where this is financed via the top-down suppression of interest rates and by wholesale misallocations of a cartelized, ex nihilo creation of credit.
Of course, the making of such a shift will be by no means a trivial task either to initiate or to see through to its end if only because the piling up of IOUs and the complex layering of both direct and hidden subsidies which has enabled so much mindless, Krude Keynesian, Keystone Krugmanite, New Deal reduplication to take place has also provided employment for one multitude, a core of seemingly reliable customers for another, and – alas! – an unavoidable outlet for the hard-won savings of them both. Not only the most shameless and venal of the princelings will therefore have a strong, vested interest in trying to perpetuate the existing schema, however much people may be aware that it cannot be continued indefinitely.
As the stilted language of the communiqués puts it, the external situation is also ‘complicated’- in other words the patterns of trade upon which China and its neighbours have built so much of their recent prosperity are now displaying at best a dispiriting stagnation and at worst an outright decline.
Thailand is a case in point: exports to China thence are back to 2010 levels and are falling at the fastest pace since the Crash itself. For all the ballyhoo about ‘Abenomics’ the specious glimmer of recovery there seems little more than money illusion. Industrial production has started to droop one more while, when rebased in the US dollars which are the regional standard, even exports are sickly – those to the rest of Asia are falling at their fastest rate since the Crash, also, to lie a good fifth lower than they did at the 2011 recovery peak.
No wonder the latest PMI fell 1.6 points to a 5-month low. Among the components, export orders were weak – mainly thanks to China – and there was evidence of a developing margin squeeze. As the report noted:-
Increases in the cost of raw materials due in turn to the yen’s weakness was cited as a key driver of rising input prices, which increased for the seventh consecutive month. Inflationary pressures were evident to a lesser degree in output prices, which grew at a slower pace than in June.
Weak PMIs were not exactly a rare occurrence, either. China, Taiwan, and South Korea all produced multi-month, contraction level lows.
What is perhaps of more concern is that, according to the latest IIF survey of emerging markets, not only were funding conditions in Asia becoming more straitened in the second quarter (in fact there were the worst of the four geographical divisions in the questionnaire), but loan demand was actually falling in all categories except real estate (where else?). Not a happy portent for vigorous second half growth and with it an enhanced call upon resources.
Continued from Et in Arcadia ego
Here we come full circle, for what this essentially presumes is that there exist no means by which to achieve the ready monetization of credit since that insidious process – which is one favoured equally by the fractional free bankers as much as by the central banking school and the chartalists – breaks the critical linkage of sacrifice today for satisfaction tomorrow which is what ensures that we do not overstretch our resources or overextend the timelines pertaining to their employment.
Though we have already touched upon the basis for this affirmation, it is so pivotal to the argument, that I will test your indulgence in trying to bring home the point, once and for all.
When credit is not erroneously transmuted into money, it means that I, the lender, cede temporary control over my property to you, the borrower, postponing my enjoyment of the satisfactions it confers because you have made it plain to me that your desire for it is currently greater than mine. This difference in preference is – like all such disparities – an exploitable opportunity for us both and, recognising this, my existing claim over a specified quantum of current goods is voluntarily transferred to you, meaning I must abstain from its consumption (whether productive or exhaustive) while you partake of it in my place in what is a wholly co-operative and, moreover, a logically and physically coherent exchange.
You, in return, promise to render me a somewhat larger service some specified time hence, as the reward for my forbearance and the price of your exigency. That surplus – what we regard as the interest payable – will therefore be seen to be the price of time not of money, much less of ‘liquidity’ as the Keynesians would have us believe. Hence, it emerges as a phenomenon much more fundamental to our psychology as mortals and to the Out of Eden impatience with which this afflicts us than to any happenstance of the ‘market for loanable funds’. Once you accept this interpretation, you are at once made aware of just what an abomination is an officially-sanctioned zero – or in some cases, a negative – interest rate and you are presumably one step from wondering whether this monstrosity can be anything other than unrelievedly counter-productive.
Next, however, imagine that I take your IOU to the bank and that peculiar institution registers my claim upon its (largely intangible) resources in the form of a demand liability of the kind which – by custom, if not by legal privilege – routinely passes in the marketplace as money. Your promissory note – a title to a batch of future goods not yet in being – has now undergone what we might facetiously call an ‘extreme maturity transformation’ which it has conferred upon me the ability to bid for any other batch of present goods of like value without further delay. It should, however, be obvious that no such goods exist since you have not had time to generate any replacements for the ones whose use I, their lender, supposedly forswore until such time as your substitutes are ready to used to fulfil your obligations, something we agreed would be the case only at some nominated point in the future.
More claims to present goods than goods themselves now exist (strictly speaking, the proportion of the first relative to the second has been artificially increased) and thus the actions we may now simultaneously undertake have become dangerously incongruous. Our initially co-ordinated and therefore unexceptionable plans have become instead a cause of what is an inflationary conflict no less than would be the case if I had sold you my place at the head of the queue for the cinema only to try to barge straight past you in a scramble for the seat in question.
What is worse, is that this disharmony will not be limited to us two consenting adults – indeed, we may both actually derive an undiminished benefit from it – but by dint of the very fact that the disturbance we have caused will ripple through the monetary aether to inflict its pain upon some wholly innocent third party who is blithely unaware of the shift in the monetary relation which we have occasioned with the aid of the bank. In our cinema analogy, the bank has given me a duplicate ticket which will allow me to bump some uncomprehending late-arrival out of the place for which he has paid and denying him his right to see the show.
Monetization in this manner has done nothing less than scramble the economic signals regarding the availability of goods in time and space. Thus it confounds rational economic calculation in the round and so begins to render honest entrepreneurial ambition moot. Such a legalised misdemeanour is bad enough in isolation, but we know that this will be anything but an isolated infraction. When banks can monetize debts, they will: when they can grant credit in the absence of prior acts of saving, they will – indeed, we demand that they do no less out of the misplaced fear that otherwise economic expansion will be derailed.
The truth is, of course, that the greater the number of economic decisions which come to be conducted on such a falsified basis, the higher and more unstable is the house of cards we are constructing on the credulity of the masses, the conjuring tricks of their bankers, and the connivance of the authorities who are charged with their supervision. Worse yet, the feedbacks at work are such that each new card we add to the pile appears to justify the installation of every other card beneath it and the more imposing the edifice grows, the more eagerly we rush to make our own contribution to this financial Tower of Babel and the more frenetically the banking system works to assist us until it finally collapses under the weight of its own contradictions.
To modern ears, more attuned to the rarefied talk of the exotica of credit default swaps, payment-in-kind junk bonds, and barrier options, this may all seem rather laboured and old-fashioned with its parallels to the classical treatment of the ‘wage fund’ and its echoes of the hard money Currency School which fought the great controversy of the 19th Century with its loose credit, Banking School challengers.
For this I make no apology, for much of what we Austrians stand for can trace its roots back to the reasoning first laid out by Overstone, McCulloch, and Torrens in that grand debate, just as our opponents tonight can trace their lineage back to the likes of Tooke, Fullarton, and Gilbart (I might here blushingly recommend to you a modest little tome entitled ‘Santayana’s Curse’ in which I deal with the relevance of the background to that debate to modern-day finance).
It is also important to bear in mind that the game of finance cannot be conducted in a vacuum, to always be clear that its workings exert a profound effect on everyday decision making and that finance is a force for good when the rules of that game are in harmony with those laws of scarcity and opportunity which govern what is loosely termed the ‘real’ economy of men and materials.
Moreover, the elision of these two types of claims – money and credit – by what must be a fractional reserve bank has dramatically raised the stakes. The near limitless, fast-breeder proliferation of credit which this enables and the facile transformation of this credit into money breaks all sorts of self-regulating, negative feedback mechanisms between supply, demand, price, and discount rate. Greater, credit-fuelled demand leads to higher prices.
Higher prices should discourage further demand, but instead encourage more people to borrow in order to play for a further rise in prices, just as it flatters the banking decision to grant such loans since the earlier ones now appear to be over-collateralized and their risk consequently diminished. Divorced from a grounding in the world of Things and no longer intermediators of scarce savings but simply keystroke creators of newly negotiable claims, our modern machinery is all too prone to unleash a spiral of destabilizing – and ultimately disastrous – speculation in place of what should be a mean-reverting arbitrage which effortlessly and naturally reduces rather than exacerbates untoward economic variation.
Sadly, my monetarist and Keynesian rivals see nothing but positives in this arrangement and given their unanimity on the issue, I would hazard a guess that the complex adaptive system types are happy enough to bow to this consensus and to accept that this is simply the way things are when they construct their models and run their simulations. The laymen – even the expert laymen, if I may be allowed such an oxymoron – have been even more united in bemoaning anything which might inhibit banks’ ability to shower credit upon everyone and anyone who asks them for it. If we had no shadow banks, who would give the aspiring taxi-driver the price of his medallion or the wannabe nest-maker her mortgage, one participant asked, as if we all took it for granted that to enjoy goods for which one has not earned the means to pay was their god-given right.
Nor do the free-fractional types, as eloquently represented here by Professor George Selgin, have any objection to the mechanism itself, being, on the contrary, keen to suggest it will do far more good than harm by dampening down fluctuations which they fear may emanate from a suddenly increased to desire to hold money for its own sake. All they ask is that the ‘free’ banks they advocate are forced to come out from under the aegis of a central bank of issue and away from the current fiction of government deposit insurance and so have no-one to shield them from the consequences of any excess or imprudence into which they might stray.
It will probably not now surprise you to learn that while we agree that banks should indeed stand on their own two feet like those involved in any other branch of business, very few of us Austrians share his sanguinity on this issue, either on theoretical grounds or as a result of our own somewhat different interpretation of the (mainly Scottish) historical record.
For our part, we would rather that the kernel of money-proper around which all other obligations are arrayed is both unable to be near-costlessly expanded at political or commercial will or shrunk as a consequence of any wider calamity. Given this fixity, we trust that any change in economic circumstances will see prices adjust to reflect that without occasioning any major harm (our model economy has undergone a radical Auflockerung by now to ensure this). Nor do we believe that credit will be denied all flexibility, certainly not within the dictates of what the saver can be persuaded to accord to the investor, or the vendor to the buyer.
It is true that this would be a world characterized by the slow decline of most prices as human ingenuity and honest entrepreneurship were continuously brought to bear on the eternal problem of scarcity, but neither would this hold for us any terrors. After the initial transition, people would soon become acclimatized to such a benign environment and would adjust their expectations and their capital structures to best fit it.
As for Professor Selgin’s bogeyman of a sudden tumultuous rush to hold money for its own sake – which apocalypse he fears above all should we prohibit his Free Banks from printing up such liabilities, willy-nilly – we see little reason to believe such impulses could reach very far up the pecuniary Richter scale in a society which had wisely denied itself the volatile mix of massive fictitious capital, extreme leverage, inflationary gambling, morally-hazardous speculation, soft-budget public choice profligacy, and reckless maturity mismatches with which we are so afflicted in our present era of easy-money, chronic price-appreciation, and the granting of overarching central-bank ‘put-options’.
Sound money is more likely to prove conducive to sound business practice and hence to a sound night’s sleep for all.
To sum up then, the only valid economics is micro, not macro; individual, not aggregate. Value is subjective not objective. The consumer is sovereign in the choice of where he spends his dollar – and all values can be imputed from where he does so – but he should first earn that dollar through his prior contribution to production.
Entrepreneurial discovery is the evolutionary mainspring which drives our secular material advance and the entrepreneurial profit motive – in an honest-money, rent-free world – is the ‘selfish gene’ of that ascent. That same motivation mobilizes the set-aside of thrift in the form of capital and capital – to risk pushing the biological metaphor beyond the point of useful illustration – is the enzyme pathway leading to the synthesis of what it is we most urgently want at the lowest possible cost.
In all of this, the workings of a sound money should be so seamless and subliminal that we pay it no more attention than we do the fibre-optic networks or 4G radio waves used for the transmission of our digital data. Finance should be based on funding – i.e., the sequencing and surrender of the right to employ real resources through time.
That economics is an Austrian economics, not a monetarist one, a Keynesian one, nor a complex-adaptive system one and I heartily recommend it to your consideration.
Continued from The Divinity School debate.
The devotees of monetarism start from the observation that what they call ‘money’ tends to move in a loose correspondence with a statistical chimera called ‘National Income’ and then proceed to reverse the usual order of the harnessing of cart to horse to suggest that this income is best controlled by manipulating the quantity of ‘money’ ex ante (and here let us spare ourselves an examination of the exact definition of that beast, in keeping with the monetarists’ own proclivity to flit promiscuously between whichever of the likes of M1, M2, M3… M(n) currently best fits the econometric bill).
Leaving aside the vexed question of what exactly comprises ‘national income’ or of whether the near infinite richness of the interactions taking place between tens – if not hundreds – of millions of people can be boiled down into one simple numerical entity, it is not really surprising that, in a horizontally-diverse, vertically-separated, modern economy, the multifarious business of accumulating, transforming, and delivering a wide array of goods and services involves the generation of a commensurate number of claims so that each individual’s part in the creation of this bounty can be duly recorded and ultimately encashed.
But it is a long way from recognising that a degree of correlation might exist between money and credit on the one hand and material wealth on the other to insisting that the forcing of extra claims upon the system can somehow encourage an increase in genuine business, an augmentation of prosperity, or a sustainable improvement in the common weal.
To believe that wonders can be enacted merely by tinkering with the availability of the medium of exchange which is our economic system’s basic plumbing is a bit like the brewer who thinks that his beer can be made to ferment quicker and taste better if only he can lengthen the span and widen the bore of his pipe-work, or like a would-be author who thinks his magnum opus is more likely to be recognised as a literary masterpiece if he doubles the spacing between the lines of his typescript and so uses twice the number of reams of paper to set it down.
This is not to say that we Austrians deny that such jiggery-pokery can have very real effects on the economy – we are, after all, the ones who are noted for our own, unique, Monetary Theory of the Business Cycle – but we do doubt that its effects are either so mechanically predictable or so universally benign as our esteemed Chicagoan colleagues suppose.
Furthermore, we are all too aware that the monotonic and comprehensive inflation of values which results from the kind of carpet-bombing, ‘helicopter drops’ which loom so large in the dark fantasises of our central banking chiefs are not the norm, but that money creation takes place at specific times and specific places and so raises some prices and enhances some demands before it effects others, thus causing all manner of largely incalculable disruptions to the all-important relative price relations which are the means by which we can determine how scarce one good is compared to another. Thus, each of their successive interventions is only likely to introduce further strains into what the earlier ones have made an already highly dislocated structure to the point that the malign effect of such distortions seems to require yet further acts of interference with the natural order.
As for the Keynesians – one almost fails to know where to begin with a hodge-podge of obscurantism which is at best a rehashed version of the old under-consumptionist fallacies, shot through with a dash of equally antediluvian mercantilism, and at worst a cynical excuse for central planning and an assault upon the sphere of private decision making.
Not the least of the sins of dear Maynard was his role as a ‘terrible simplificateur’ in his championing of a school of accounting tautology that too many of us have come to revere as ‘macroeconomics’ – a many-headed monster of a thing which all too often tends to controvert the eminently sound insights of micro-economics once the latter’s transaction count crosses some strange, reverse quantum threshold of weirdness.
We have heard some of the peculiar effects of this tendency here tonight in being assured, among other things, that the only salvation of a people brought low by borrowing too recklessly is to find another agency – Burckhardt’s arch ‘swindler-in-chief’, the state, if no one else – to take their place at the high table of prodigality.
We have also been told that public debt is an ‘asset’ that we owe to ourselves – a contention which not only flies in the face of logic, but also of much of history – and that we cannot all export our way out of difficulty, when the very marvels of modern society have been exactly so built up by each man, much less each nation, ‘exporting’ as much value as he can to his fellows, thereby earning the right to ‘import’ as much as he would like from them as his due reward.
Above all, we have been enjoined to assume that everything wrong in the outmoded world of laissez-faire is the consequence of someone – usually someone assumed to reprehensibly better-off than the norm – failing either to exhaust the entirety of his income on fripperies – so triggering a nonsensical ‘paradox of thrift’ – or to spend any such surplus of income over outgo on fixed income securities – so delivering us to the legendary Château d’If of the ‘liquidity trap’ instead.
Needless to say, we hold the opposite to be true. We hold that thrift fuels, rather than frustrates, material progress and that the only ‘liquidity trap’ we have to fear is the snare that results from the provision of too excessive a supply of ‘liquidity’ – i.e., of a great superfluity of money and the promise of artificially cheap credit for ‘as long as it takes’ – in the aftermath of the Bust. This utterly wrong-headed approach only attenuates the purgative effect of the crash and so leaves too many men, machines, and minerals locked into too many failed endeavours at what are still too-elevated prices for their redeployment to alternative uses to promise a decent return on the undertaking, this preventing economic rejuvenation.
In the authorities’ Humpty Dumpty compulsion to validate every sunk cost by suppressing interest rates – and thereby suppressing a good deal of the useful risk appetite and channelling too much of it into the narrow field of financial speculation – they only succeed in sapping the survivors of their remaining vitality. On the one hand denying the least afflicted (among whom are to be found, by definition, our potential saviours, the wiser, the more resilient, and the more flexible) the opportunity to rebuild amid the rubble, they thereby hand the reins instead over to an enervating alliance of extractive, public-choice parasites, skulking subsidy-grubbers, feckless leverage jockeys, and special-pleading, sub-marginal zombie companies
Among other enormities, the fact that production must necessarily precede consumption and that it is the first which comprises the creation of wealth and the second which encompasses its destruction, was far beyond the ken of the spoiled Bloomsbury elitist who exhibited a life-long contempt of the aspirations and mores of the bourgeoisie and who hence imagined that policy was at its finest when, like an over-indulgent aunt, it was pliantly accommodating the otherwise ‘ineffective’ demand being volubly expressed by the old dame’s petulant nephew as he stamped his foot in the tantrum he was throwing up against the sweet-shop window.
This article is the second in a series. Continue to Part 3: Been there, done that, bought the T-shirt.
“…the stoppage of issue in specie at the Bank [in 1797] made no real addition to the financial powers of the country. On the contrary, it diminished considerably the real efficiency of those powers, while it introduced a facility in money-transactions, which has cost the country more in real comfort, and will probably cost it more in lasting expense, than any circumstance that has ever occurred.”
“If there had been less facility, there probably would have been more utility in those transactions; money would have been more valuable and more valued. The [fixed income] stocks probably would have been lower in price, but certainly no less deserving of confidence. There would have perhaps been a larger discount on floating [short-dated] securities; but there would have been fewer complaints of the expense of living; and, above all, the country would have had the unimpaired glory of having resisted all dangers from without, as well as within, without the sacrifice or suspension of any one principle of public faith.”
Reply of Walter Boyd to a letter from a friend sent 9th January, 1801
‘The Future of Finance’ was a conference convened in May by the Knowledge Transfer Network with the support of, among others, the Institute for New Economic Thinking and Oxford’s Said Business School. As part of the programme, a debate was staged between the representatives of four ‘schools’ of economic thought – the Monetarists, as represented by the former ‘Wise Man’ Professor Tim Congdon; the Keynesians, as championed by Christopher Allsopp, formerly of the BoE’s MPC; the Complex Adaptive Systems approach of Professor Doyne Farmer of ‘Newtonian Casino’ fame, and the Austrians whose corner was fought by yours truly.
The following essay attempts to expand upon the arguments I made that night in what was obviously a much more concise form, together with some more general thoughts thrown up by the conference at large. Since the event in question was deliberately – if courteously – adversarial and given that it was consciously staged as a species of entertainment, rather than one of deep academic debate, it will be apparent that none of us protagonists were fully able to develop our views beyond what could be incorporated into a few minutes’ pitch to our audience.
Moreover, none of us were allowed any subsequent opportunity for further attack or rebuttal, but could only respond, in the round, to a sampling of questions posed by the audience. In the circumstances, if the arguments of my opponents seem in anyway superficial as I summarize them here, I trust they will be gracious enough to accept, by way of an apology, the acknowledgement that my own propositions on the night will have seemed no less denuded of context or justification than perhaps did theirs.
Their bloody sign of battle is hung out
Ladies and Gentlemen, if you have heard of us ‘Austerians’ at all, you probably have in mind a caricature of us as loony liquidationists, eager for a Bonfire of the Vanities in which to purge the sins of all those who seem to have enjoyed the late Boom rather more than we did as we paced up and down outside the party, weighed down with our sandwich boards on which were emblazoned the injunction, “Repent Ye now for the End is nigh!”
Naturally, I don’t quite see it like that, nor do I feel shy about proclaiming our virtues over those supposedly possessed by the Tweedledee and Tweedledum of macromancy – the monetarists and the Keynesians – whose alternating and often overlapping policy prescriptions have, in the immortal words of Oliver Hardy, gotten us into one nice mess after another.
The monetarists – or perhaps we should call them the ‘creditists’, since they are not often overly clear about the crucial distinctions which exist between money, the medium of exchange, and credit, a record of deferred contractual obligation – tend to be children of empiricism. I hasten to add that, for an Austrian, there are few greater insults that can be bandied about: Mises himself once waspishly observed that the modern dean of monetarism, Milton Friedman, was not an economist at all, but merely a statistician.
To digress a moment, ‘money’ is different from ‘credit’ and the refusal to consider how, or in what manner is what leads to many errors, not just of thought but also of deed, for if there is one thing that modern finance is pre-eminently equipped to do, it is to transform the second into the first and thereby pervert the subtle webs of economic signalling which are so fundamental to our highly dissociated yet profoundly inter-dependent way of life.
We could of course come over all philosophical about money being a ‘present good’ – indeed, the archetypical present good – and about credit being a postponed claim to such a good. We could then go on to point out that, far from being a scholastic quibble, such a distinction is of great import to the smooth functioning of that vast assembly line which we call the ‘structure of production’ and that to subvert their separation is to call up from the vasty deep the never-quite exorcised demons of the ‘real bills’ fallacy and to begin to set in train the juggernaut of malinvestment which will soon induce a widespread incompatibility among the individually-conceived, yet functionally holistic schemes of which we are severally part and so lead us through the specious triumph of the Boom and into that grim realm of wailing and the gnashing of teeth we know as the Bust.
Later, we shall have more detail to add to this, our Austrian diagnosis of the role of monetized credit in the cycle, but for now let us instead point out that money is a universal means of settlement of debts and thus acts as a much-needed extinguisher of credit. In making this assertion, I have no wish to deny that the latter cannot be novated, put through some kind of clearing mechanism, and hence cross-cancelled, in the absence of money – as was the often nearly attained ideal aim at the great mediaeval fairs, for example – simply that the presence of a readily accepted medium of exchange greatly facilitates this reckoning. Furthermore, though a new crop of expositors has sprung up to make claims that credit is historically antecedent to money (though the plausible use of polished, stone axe-heads as a proto-money which was current all along the extensive Neolithic trade routes of 5,000 years ago might give us renewed cause to doubt this now-fashionable denial), this is hardly to the point in the present discussion.
Money may or may not have sprung up, as is traditionally suggested, to avoid the well-known problems of barter, but, however it arose, what it did do was obviate the even more glaring impediments of credit – namely that, as the etymology of the word reminds us, ‘credit’ requires the establishment of a bond of trust between lender and borrower, a trust whose validation is, moreover, subject to the vicissitudes of an ever-changing world by being a temporally protracted arrangement.
Thus, while money’s joint qualities of instantaneity and finality may confer decided advantages upon its users, its main virtue indisputably lies in the impersonal nature of its acceptance in trade for it is this which frees us from the limited confines of our networks of trust and kinship and so greatly magnifies the division of labour and deepens the market beyond all individual comprehension in a mutually beneficial, ‘I, Pencil’ fashion.
For its part, credit certainly may help us get by with less money, never moreso than when we have become drunk on its profusion and giddy at the possibilities this abundance seems to offer amid the boom. Then, we may truck and barter more and more by swapping one claim for another almost to the exclusion of the involvement of money proper but, as the great Richard Cantillon pointed out almost three centuries before Lehman’s sudden demise forcefully impressed the lesson upon us modern sophisticates once more,
…the paper and credit of public and private Banks may cause surprising results in everything which does not concern ordinary expenditure… but that in the regular course of the circulation the help of Banks and credit of this kind is much smaller and less solid than is generally supposed…
Silver alone is the true sinews of circulation.
This article is the first in a series. Continue to Part 2: Scylla & Charybdis.
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.