Post added to on August 13, 2010 – last few paragraphs
The latest reason people are getting their knickers in a twist is Laurence J. Kotlikoff’s ruminations on the de facto bankruptcy of the USA. Professor of economics at Boston University, Mr Kotlikoff bases his comments on an IMF report that sets forth some indisputable arithmetic whereby current and projected US GDP falls short of satisfying current and projected state spending to the tune of over $150Trillion over the next twenty years or so. That’s Trillion with a “T”.
Kotlifoff’s Bloomberg article is being pored over and dissected by some of the brightest minds in the world as well as some of the less bright bulbs in government and everyone has something to say about it whether for or against the arguments set forth.
Rather than adding to the analytical cacophony, I prefer to whittle down the argument to simpler terms and it goes something like this.
Short of returning to barter, we have no choice but to make use of some type of money. In actual terms, money is just like barter but since it allowes us to break down the value of an item in small fractions of value, it allows people to interact more easily than, for example, exchanging 20150 shovels to buy a car. Instead, you sell your shovels for bits of value that you then can deposit or carry around in order to exchange for other items and services you require.
So, money is necessary and is a fantastic concept.
What remains to be chosen now, is how the monetary system is to be managed.
In our life time, since 1913 to be precise, nations have gradually moved to a fiat monetary system. The USA were the first to adopt fiat money but then since 1971 gradually all other countries world wide have followed suit.
Fiat money is a rather ingenious concept to be fair or, at least, it could be. But the variety of fiat money first adopted by the USA and then imposed on the rest of the world is inherently self destructive as has been proven several times since the advent of modern finance in the 1500s. The variety of fiat money adopted by the USA in 1913 is the type that is predicated on the perpetual expansion of the monetary base ergo inflation.
At this point we can debate whether the choice was deliberate or forced and whether or not it was born of ignorance or intent. But that is not the point I wish to make. The point is that this is the monetary system we have to contend with.
The historical logic of fiat money has manifested itself several times since 1913. As the sole users of fiat money from 1913 to 1970, the USA first flirted with bankruptcy in 1929 only a short 16 years from adopting the system. In fact, the depression engendered then lasted up till WWII when the USA emerged as the only standing industrial power. As the only manufacturer to the world, the USA were then once again free to expand the monetary base in leaps and bounds without immediately suffering the effects of inflation. But by 1970 the cows were, once again, coming home and the USA were de facto bankrupt … yet again.
In 1971 salvation came in the form of the abrogation of Bretton Woods so that the then industrialized world moved onto a system of US$ based floating exchange rates. Thus since 1971 first Europe and then gradually all other countries have moved onto a fiat monetary system based on the US Dollar. Thus, regardless of when a country has adopted fiat money, due to the magic of floating exchange rates, today we all must contend with an inflationary dynamic that is just shy of 100 years old.
That is a lot of inflation.
Now; economists can calculate, extrapolate, study and dissect data but the logic of fiat money is well known. The only variable is time but the conclusion is inevitable and has been evidenced several times since the Renaissance. To be fair, history is replete with examples of catastrophe brought about by monetary debasement whether fiat or otherwise. It is just that fiat money is that much easier to debase masked as it is by government’s ostensible fiduciary duty.
So government makes the arbitrary and unilateral decision to adopt fiat money. Fiat money is predicated on inflation ergo it is predicated on the debasement of the currency.
So what’cha gonna do!!
Government is an entity. As an entity, government has made a choice that it thinks will allow it to achieve its ambitions. This choice was made 100 years ago and then imposed on all other governments. For governments and politicians today to come out and express doubt regarding a decision taken 100 years ago and that, in fairness, appears to have worked rather well, is unconscionable. Of course, we will never know what an alternative monetary system may have brought about but what we got for the past 100 years is not so bad. So why stop now. Quite the contrary. Government thinking at this point goes something like this. If 100 years of debasement have brought us this amount of development (and profit), then why not just do more of the same.
Of course, few ever stop to consider that debasement cannot be and is not infinite. If it were infinite, then the majority would not need to work at all. All we would need is to employ a handful of geezers to operate the money printing press and everyone else could safely kick their feet up and Bob would be your uncle right?
But debasement cannot be infinite because perpetual motion has not as yet been discovered and because Achille and the Tortoise argument is demonstrably false too come to that.
But… but… but… as the initial instigators to adopt fiat money and as the only and most vocal proponents of the system, the banks are perceived as the one and only pillar of life as we know it. At least, that is how government thinks evidenced by how all Western governments have responded to this crisis. And banks are now once again profitable. In actual fact, banks are making money hand over fist. So much so in fact, that never in the modern history of banking bonuses of this size have ever been paid out.
So that, if banks are making money, it means that we truly are in a recovery. How could banks turn a profit otherwise? Tim Geithner’s latest ramblings evidence such sanguine view of the world as viewed by bureaucrats.
And since in a fiat monetary system banks are the linchpin of the entire construct, if the banks are doing well then let the good times roll. That’s because, it is thought (or it is pretended), that if the banks are making money, this money will translate into loans which in turn will translate into economic activity and thus in expansion of the economy thus, eventually, in more money for the banks. And everyone should be happy.
The question of course is: are you happy?
Overlooked by almost all, is the fact that banks, in fact, are making money. But a significant chunk of the money they are making is due to government largesse and overtly and blatant preferential accounting treatment. Banks today cannot lose. Granted it is not all banks that cannot lose but certainly the banks members of the Federal Reserve cannot lose.
But, to return to Kotlikoff. As most pundits, analysts or economists, we’re all wringing our hands about something that in fact is following a logical evolution that is inherent in the system and the driver of which is the monetary system. Fiat money eventually obliterates itself. Fiat money in a democratic context eventually brings about the demise of government. The only variable is time and, certainly, government aggressive and continued intervention can stretch out the time line. But the longer you push back the natural tendency of the system to reset the more force you accumulate for the eventual unraveling.
What now remains to be seen is how the unraveling will come about.
As I never tire to repeat in these pages, modern government (whether democratic or autocratic) cannot contemplate any monetary system other than fiat. Fiat money is a brilliant construct. It is flexible and it is adaptable if easily manipulated. So that once we’ll come out of this crisis, I have to believe we will once again institute a fiat monetary system.
But from now till we emerge from this crisis, what are the likely events that will shape our lives? Since the viability of fiat money is predicated on inflation it follows that the system must constantly be fed at the bottom by assimilating new currencies and new markets. In the 30s monetary or political unions were unthinkable so that the crisis eventually was resolved by war. In the 70s, the monetary system absorbed a whole bunch of currencies so that then excessive US$ inflation could be released into European markets. Then came the Euro. Then globalization. Today, the US$ monetary system has assimilated all markets and all currencies. And guess what. We are today where the USA were in 1929 and 1970. That is we are now bankrupt. So what now? Bankruptcy is only deleterious to the extent that government cannot meet the social promises it has made. As social expenditure is curtailed, social unrest follows. As these two dynamics reinforce each other, the risk of revolution becomes real. But the West cannot allow revolution within its “civilized” borders. Revolution is something that happens in banana republics, not in the developed civilized West. So, watchyagonna do?
In my opinion the only thing that can now allow us to unwind the amount of inflation we have accumulated since 1913 is a war. A global war that is. And I’ll go out on a limb too on this one.
Regardless of where the war starts and why which cannot be predicted (we are neither short of excuses or triggers presently), if I am right and we are about to be plunged into a world war, I can predict where the war has to be taken to and that would be to a band of land that snakes from India through China to South Korea.