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These essays have been written between June 2007 and September 2009. They are in no particular order and I have gathered them on one continuous document because my blog page was getting too cluttered.
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Background of my contention – the how and why
I haven’t always been a Cassandra. Honest! I haven’t. Granted, I’m more of a cynic than your average salvation army drummer, but in the past five years, things really have taken a turn for the worse at greater speed than even I thought likely. To be sure, I do ask my friends to provide me with data points that might allow for some sort of positive interpretation but, so far, nobody has come through with anything that stands up to scrutiny. So, till then, I have to assume I am right till proven wrong.
I admit I’ve been predicting doom for some years now and, evidently, have been wrong. So, you may ask, what makes me so sure I am right this time around? The answer is that I am not sure. I never have been nor am I now sure I am right. What I can say, is that the same indicators that told me things were out of whack in the past are indicating that things still are… only more so. So, in my opinion, the question is not whether or not I am sure I am right, rather, at what point does a trend pass the inflection point after which it brings about doom.
Let’s be clear here. Like most anything else, doom is not an event; it is a process. I am not talking here about the sort of natural disaster doom i.e. an asteroid colliding with earth or a devastating tsunami in New York. Here we are concerned with your garden variety daily routine of life, during which, doom is something that builds up as a consequence of the collective effect of human actions. And this time, I think we’re in for it.
I’ll say here and now that we were supposed to be in for it in 2000/2003 but then along came 9/11 and as if by miracle, we were able to re-start inflation again and we went on to enjoy a few years of what was thought to be great prosperity.
Except that it wasn’t.
If you’ve followed me here from Face Book then you will know that my pet peeve is inflation. Inflation induced by necessity through politics and by the inevitability of human behavior.
I’ve predicted doom once before in my life and, of course, been almost right… but otherwise wrong. Here’s where I come from. Like the protagonist in Slum Dog Millionaire, I draw my conclusions from my experience of life and people.
I’m a late bloomer. I had no particular interests at all till fairly late in life. In the 90s whilst working with the opening team on the first ever Disneyland park and resort in Europe to open near Paris, I had my first taste of human psychology; specifically, group psychology. Disney makes for a fascinating environment in which to observe people. As an organization, Disney itself warrants writing a book about but that’ll be for another day. The Disney experience can be traumatic for “cast members” as employees are defined. Few can claim to survive the Disney experience unaffected and it was not different for me. But what Disney illustrates, is that human behavior across societies can vary in style and degree but not in essence. French and Italians may not enjoy the food served at Disney and may complain that wine is not served in the park, but they will still hold on to a piece of garbage for a maximum of ten paces before chucking it; and the single most frequently asked question by the public in the park is still “where are the toilets?”. [ Disney conducts a bewildering range of studies to predict the behavior of people and their desires. One of the things they found out was that a person will hold on to a piece of trash for about ten paces before discarding it. So Disney places garbage bins every ten paces around the park.] In that respect therefore, when moving into Europe Disney’s marketing and organizational strategy weren’t as off base as the style and delivery of the product. Overall, they still had to contend with a set of human attitudes, expectations and priorities that transcend cultures and time.
Then in 1995 I joined a recruitment firm in London specialized in international hotel and hospitality recruitment. In 1997 I moved to Portfolio International, a larger executive search firm catering to the same industry from London. Despite the fact I lacked the historical context and was largely ignorant of any social science, the seven years I spent in recruitment allowed me to piece together a tapestry of empirical evidence that formed the basis of my first prediction of doom. It is only from 2001 onwards that I began to delve in the academic side of what I was experiencing in real life.
Whereas at Disney I received a fairly good grounding in what makes masses tick, my recruitment days gave me a sense of the wider economics context, money flows, wages and social dynamics in the world. Of course, the period of time from 1990 onwards started with a recession and witnessed the rise of capitalist China, the emergence of capitalist Russia, the end of Gulf War I, the then apparently inexorable rise of the Dow Jones and the advent of a “new era” of productivity, irrational exuberance, the fight for global democracy, a few economic crisis of first order in Mexico in 1994, in Argentina some years later, then in Russia, then in the USA with the implosion of LTCM… in short it has been a period of time not devoid of thrill and apprehension. But the interesting thing for me was that through my activity of international recruitment, I was witnessing the social and economic effects of each event first hand. Not only did I have a front row seat to what happens to people and how they behave in a given set of social and economic circumstances but also, I witnessed how governments deal with crisis, how foreign governments and international institutions intervene and how things evolve. Also, living and working in one of the epicenters of world finance that is the City of London and frequenting that symbol of success that is the gastronomic restaurant scene, I could see the effects of world events on the people that often had a hand in shaping them or that, at the very least, were in the front line of the repercussions.
One of the very first things to strike me as odd when I began in recruitment was how much compensation packages in the international hotetl industry had decreased over the years. I grew up, studied and worked in different countries in Europe, the Middle East and, briefly, in the US. When I began working in recruitment, I was acutely aware that the traditional, social and economic context of Europe did not allow professional progression at a rate compatible with the rate of growth of the population. I knew for example, that there was only the slimmest of chances to make a career in the prviate sector in Italy, any sector, and that professional flexibility is precluded by a scherotic political context that is not geared towards innovation. So I thought that the international market would be the solution for many young men like me.
However, the very first thing I noticed when I began to work in recruitment was that a newly recruited Executive Chef in an international chain hotel in the Middle East would command a far lower compensation package than in the late 70s. Of course there are highly paid executives too in the industry but that is something that happens only after many years of effective and loyal service in a company. In the meantime, starting salaries were nowhere near reasonable in light of the cost of living one would incur when moving a family to a new country and sending children to school. Come to that, since the golden age of the 70s and 80s, hotel companies seemed to gradually move away from providing perks such as schooling, travel allowances to home country and accommodation to anyone but the General Manager and, to a lesser extent, to other members of the executive team.
That was the beginning of my incapacity to reconcile the outward appearance of wealth and economic prosperity in the West on the back of global wages that were declining nominally and on a relative basis across a number of sectors particularly in areas of primary importance as education and helath.
But wonders did not stop there.
I received my first lesson in economic perception when I made the move from the first relatively small recruitment firm to Portfolio International. If you must know, the first firm I joined was called VIP International. I don’t often mention it because although Mr. Bianchin the founder of this firm was quite a personality on the international hotel scene during the 70s and 80s and the name of the firm would have been appropriate then, in the 90s the name “VIP International” in London conjured images of slinky voluptuous ladies clad in form fitting ware more than anything else. Going back to my story; when I moved from VIP International to Portfolio International I thought I was joining a larger firm with more clout. After all, PI was quoted on the stock market and employed what in comparison was an army of consultants. At VIPI we were all of 4 consultants at peak; when I first joined PI in 1997 we must have been a good 15 consultants of whom five worked on the international market and the rest worked on the UK market. Although I enjoyed the work greatly, it became gradually clear that our strategy was dictated by the imperatives of the stock market regardles of intrinsic performance. During my 5 years at PI, we went from a quaint 15 consultants to at one point something in the range of 45 employees. Recruitment is an activity that has no entry barrier at all and the industry is saturated with firms large and small some of which don’t last more than a few months in business. Everyday dozens of new recruitment firms are launched all hoping to eke a living out of the same clients and the same candidates as everyone else. All that is required is a telephone line and some contacts. Obviously, in such an environment, quantity and speed become much more important than quality and commitment and so it is that, much like the author of Liar’s Poker described, we reached the stage where we had 18 year old “consultants” with no experience working the international market. During this time, our database also increased many folds to the extent that each consultant was handling a database of several thousand names; the same names that all other recruitment firms around the world were also handling.
The epiphany – well, one of the first epiphanies that is.
At the hight of activity, our CEO David Coubrough decided that we were important enough and succesful enough to retain the services of a company that came around a couple of times a week to… wait for it… wipe down our telephones and computer screens. This was not the same company that cleaned the office. This was a service company that wiped phones and pc screens. I know what you are thinking or at least, what you should be thinking. That was the point at which the absurdity of the charade began to dawn on me.
We were now a regiment of consultants generating prodigious amounts of activity but the performance of each individual consultant was diminishing. Compared to the increase in activity and revenue, resource consumption in paper, electricity, telephone, travel, water, office supplies and office rent increased faster.
But I truly enjoyed the work and thought that it would really be worth it and desirable to bring about qualitative change to boost efficiency. And so I tried to get involved. David Coubrough and the team appeared intellectually receptive.
Warning! The next few paragraphs are partly relevant to the broader discussion and partly a venting excercise on my part for having been screwed out of a few thousand Pound Sterling by people I thought had genuine intentions. For the purpose of the broader discussion you can safely skip the next two paragraphs and go directly to “the moral of the story”.
During the first phase of the global crisis of 2000 long after I had already made my prediction of doom, David Coubrough asked me to help support the company stock price. At the time there was a possibility that I could have a larger role in the international department of the company bringing about the change I thought would be desirable so I accepted. David also promised that he would underwrite any potential loss I may incurr. Although the gesture was unnecessary in light of the strategy he was willing to pursue with me, it was nonetheless appreciated. Two years later in the wake of 9/11 it was clear that the change I thought we needed to effect was not coming about and we decided to part ways. The separation was very amicable and David asked, and I agreed, that I hold on to the company stock and to coordinate with him the eventual sale.
Little did I know that David Coubrough was negotiating the sale of the company and that one fine day he rode off into the sunset leaving me to hang dry with my shares and not a word of acknowledgement. Even worse, after he’d gone, I proceeded to get screwed for another 3000 UK Pounds by the new CEO Lesley Reynolds whom disowned any agreement I may have had with her predecessor and former boss.
The moral of the story –
Although a minor quoted company, we now know that the attitude at PI is in fact pervasive in the Western inspired political and business worlds. Inflation is the one vital dynamic in the absence of which government and the political process would be greatly reduced and, at times, paralyzed.
What mattered here was not individual performance and efficiency. What mattered here was appearance. What mattered was total company turnover because that single number insignificant as it may have been, gave an impression of size thus stimulating our CEO’s ego and hopes to sell the company for a higher price than it was really worth.
What we were doing, was inducing inflation in our company’s turnover. The reasons we were doing that are the same as the reasons why politicians need and want to induce inflation in the economy.
Why a world war?
Most of you are incredulous that a world war could happen in these our “modern” times.
Those (few) of you that agree that eventually there will be a war, do so, by and large, out of a desire to convey the image of the citizen concerned about morality and the ostensibly detrimental effects of progress and modernity but are at a loss to identify the dynamics and reasons for war.
In reality, most of you think that today a global conflict is impossible because… because… (and here you usually cite the most trite reasons).
A war of global proportions is not only possible but probable by 2012 and, unless someone is able to re-start the inflation dynamic, certain by 2015.
I can see you rolling your eyes.
You remember I told you that the moment a country willingly adopts a fiat monetary system, then the existence of the state and the political process are predicated on inflation. (here)
You remember I told you that inflation brings demand and production forward in time. (here)
You remember I told you that inflation is inherently and by necessity exponential. (here)
You remember I told you that inflation has a mathematical limit. (here)
If inflation brings production forward in time and if inflation is inherently exponential, then production capacity darn near follows at the same clip.
Now, unless credit creation and the expansion of the monetary base go hand in hand with constant or increasing velocity of money, then industrial capacity utilization should necessarily decline.
Here is a peek at industrial capacity utilization courtesy of Calculated Risk and, indeed, despite being sinusoidal, the overall trend goes from the top left to the lower right. (here)
Connecting the dots:
We are building more factories and producing more goods but despite a rapid increase in debt obligations, our ability to absorb all this production capacity has been steadily declining for a good many years.
Our governments are hell bent on restarting demand (i.e. inflation) that is what the gargantuan money creation is aimed at.
However, as attested by the velocity of money, not only is the currency being created not entering in circulation but credit creation is cratering.
As money no longer circulates and as credit creation contracts, the economy contracts too.
As money and credit are not circulating and the economy contracts, unemployment soars.
As money and credit contract, and unemployment soars, government revenues (taxes, levies, duties…) dwindle.
As government revenues dwindle, governments are unable to meet their financial obligations internally or, indeed, externally.
As governments cannot meet their financial obligations and as unemployment soars, the masses get twitchy.
Of course, the preferred solution to this type of situation would be to, once again, fire-up demand in some asset class.
Reinvigorated demand will spur credit creation and, presumably, the velocity of money thus inflation.
The fly in the ointment is that despite fierce credit creation, the velocity of money has been declining for over two decades. The other fly in the ointment is that despite fierce credit creation, industrial capacity utilization has been inexorably declining too over the same period of time. The other fly in the ointment is that the purchasing power of national currencies has been eroded to within a few basis points of its entirety. The other fly in the ointment is that despite fierce money and credit creation in the double digits, GDP for the past 30 years has, in a good year, expanded by 6% annual but more often meandered around 3%.
So, how can a global conflict help?
There are only three ways the inflationary dynamic can be restarted at this point.
The first option consists in being able to bring into what is today a global monetary and banking system a new market or currency. However, in light of the fact that every single country in the world is already on a Dollar based Fiat monetary system and fractional reserve banking, I’d say that is a no go.
The second option would be to introduce a new currency so as to devalue the previous currency (think Euro). However, given that all countries in the world are effectively on a USDollar standard, introducing a new currency at global level and at short notice, would require a degree of authoritarianism that would make the most ardent Marxist or Fascist balk.
The third option is to… drum roll… destroy industrial capacity at global level.
That’s what a war needs to achieve. Without mentioning that, suddenly, the attention of the masses will be focused on some foreign “evil” character and not only will we be able to use scores of unemployed to be sent to the front but we can employ the rest once civilian industry is converted to war industry.
That is the reason I bet we are hurtling towards a world war. How war is initiated and where, matters not in the least. What does matter is where the war has to be taken and what it has to accomplish… and that is the obliteration of industrial capacity.
From where I am standing, the one most basic thing you can do to monitor the likelihood of war is to monitor the velocity of money. It is imperfect but a darn good proxy to monitor the presence or otherwise of inflation in the system.
No inflation = world war
What’s going on – my opinion and not so improbable scenario
You’ve read my rants and ravings and you are probably inclined to think I am a crank. After all, how can Guido be sitting there seeing things that the great and the good cannot see particularly considering that he avails himself of published data and news articles available to all. Entertaining though he may be occasionally, Guido mostly dramatizes for effect.
Bear with me. We know for a fact that the USA, Europe and England have officially borrowed in excess of US$3Trillion to ostensibly counter the crisis. This sum does not take into account the guarantees each government has put up. This is just the physical amount of money that has been requested, approved and is being transferred.
From a recent Bloomberg article we read: “If atonement is difficult, retribution may prove “brutally difficult,” Starwood Capital Group CEO Barry Sternlicht said in an interview in Davos. As Sternlicht sees it, “everyone wants a head, and that’s not reasonable. To do that, you’d need to take out the top 20 executives at the 300 biggest financial firms.”
Sternlicht gives us an estimate of 6000 people that are directly involved in this scandal – because it is a scandal.
Let’s take the 6000 people Sternlicht is talking about (300 biggest financial firms x 20 executives per firm) i.e. Thain, Trichet, Paulson, Bernanke, Cameron, Goodwin, Greenspan and so forth and lets assume they were the only and ultimate puppet masters. As puppet masters, they operated through a gaggle of minor figures a good number of whom were politicians. To be generous, let’s assume that Sternlicht’s 6000 top executives influenced and enacted policy through a gaggle of 10000 minions. So we now have an estimated gang of 16000 people involved in the scandal. Let’s round that number to 20000 to be generous.
So, we have a band of 20000 around the world that somehow genuinely did not, could not or did not want to see what was clearly suspect, undesirable if not criminal behavior in the past 15 years. Things like companies selling debt and using the proceeds to buy back their own company stock so as to artificially inflate the stock price. Things like Fannie Mae unable to publish its accounting books for a period of 18 months not 2 years after the Enron event. Things like GM no longer making money in its core business (vehicles) and making up the shortfall with suspiciously juicy profits from its finance arm GMAC. Things like banks making use of off-balance-sheet instruments called SIVs. Things like negative ammortization mortgages in the face of what was clearly a bubble… you get the drift… there was no shortage of red flags in the recent past and yet, apparently, nothing appeared to be out of whack for the world elite economists and politicians. Fine.
Of course, we can argue that professional economists also somehow completely failed to notice the long term decline in the velocity of money despite the fact that the rate of expansion of financial debt was outpacing GDP expansion at an accelerating rate for the past 20 years. But, let’s not get technical here.
So, we have a band of 20000 (twenty thousand) that thought nothing was amiss in the past ten, or even, the past five years.
Our leaders have now borrowed US$3Trillion (that’s twelve zeros) and it is likely that Obama this week will request another whopping amount as will the EU and England in the coming weeks. I estimate that before the year is out, we’ll be talking of amounts in excess of US$7Trillion… a large sum in and of itself but nothing compared to the sum it is supposed to off-set estimated by the BIS at well over US$500Trillion in various debt instruments world wide.
(See also Steve Keen’s Debt Watch article in this regard also posted an commented on this log under “Current events: eco and pol”)
What is the use of pitting 7 Trillions against a potential default of 500 or even only 50 Trillions?
The answer is two fold. Our leaders are not attempting to counter the deleveraging of the debt mountain. If that were the case, they should be talking of sums that are ten, twenty or thirty times larger than US$7Trillion.
What our leaders are doing is to make whole the gang of 20000 that got us into this mess.
The 20000 are making out like bandits. They will plunge us in a world war which will presumably bring about the much talked about New World Order that Gordon Brown is so proud to discuss in public fora these days.
7 Trillion Dollars divvied up amongst the 20000 is a cool average of 350 Million each. In a deflationary environment, that’s a whole lotta moola.
These calculations are based only on the official numbers common mortals like you and me have access to. Undoubtedly, there are huge sums changing hands behind closed doors that we will never hear about.
Still think I am a crank?
Thoughts on Stiglitz Vanity Fair article
If I had to identify one single dynamic that is causing now and has caused in the past the failure of the socio/economic/political system, I’d have to point the finger at human nature. That is because all dynamics are subject to failure just because that is inherent in the logic of a dynamic. A dynamic exists because of differences in the environment. If there were no differences in the environment there would be no dynamics hence no matter (molecules and atoms) and no life. As an imperfect analogy, take air pressure. If air pressure were the same throughout the planet then there would be no air currents and no wind. Constant air pressure would indicate also constant temperature therefore no seasons and no contrasting environments such as glaciers and deserts. The absence of air current would also preclude the pollination of certain species of plants. And so on and so forth. Dynamics exist because matter exists and that is how life comes about. Life itself is a dynamic that comes into existence, develops and dies.
That being so, humanity is unique in the sense that of all the species, we seek to not only dominate but also control our environment and shape its future – and we do that by creating synthetic dynamics that we add to the environment (as opposed to enduring natural dynamics).
Although politics, economics and social sciences may appear unrelated, they are all human dynamics that overlap and have a shelf life. The shelf life of these dynamics is enshrined in the process of the dynamic itself because as it is applied to modify the environment, its utility diminishes as its objectives are achieved or not. The outcome, whether intended or not, inherently modifies the environment therefore requiring the original dynamic to be modified or stopped and/or a new dynamic to be devised.
Communism, Fascism, Democracy, dictatorship, market economy, statist economy, monetarism these are all dynamics created to achieve human goals that pertain to comfort and prosperity through control of the environment. I am not going to delve here in the merits or otherwise of each system as my only intention is to indicate that these dynamics have been created and applied at various stages of human development. What I feel is important to understand here is that dynamics do have a sell-by date that, as is very well documented throughout history, is always and everywhere disregarded.
In fact, human nature is such that if something appears to be good at the beginning, then more of it is perceived to be even better. So it is the case that more often than not, when the best thing to do would be to just do nothing and let a dynamic extinguish itself, humans apply themselves to do something. This is when systems go critical and give rise to distortions and aberrations.
“How the f#@k does this tie in to the article”? I am glad you asked. If you haven’t yet glazed over, I’ll tell you how.
From a historical point of view, we are very fortunate to be living one of those rare moments in human history when the social, political and economic cycles are coming to their logical conclusion at the same time. Make no mistake! This is a momentous occasion that happens rarely, only every few generations and we are the actors living and shaping this one.
Whether we like it or not, modern money (the pieces of paper and coins in our pockets) is a great tool. It is portable, flexible and reasonably resistant. IT IS A TOOL and a darned good one too. What modern money is not, is VALUABLE. In other words, the stated value of the $100 dollar bill in your wallet is not its intrinsic value.
If you understand that, then you may legitimately wonder what makes a $100 dollar bill worth one hundred dollars.
Enter economics and politics.
For the purpose of this discussion, when I say “modern” money I am referring to currencies post Bretton Woods hence from roughly 1971 onwards.
If we agree that money is a tool bereft of intrinsic value, then by necessity the total value of money of a country should closely mirror the value of that country’s wealth as measured by the output of its primary, secondary, tertiary sectors of the economy and, today, the quaternary sector too apparently. By “closely mirror” I mean that the amount of money available should take into consideration that the economy is not static and can expand and that population may grow. Therefore, it is desirable to have an amount of money slightly in excess of the total wealth of a country. So, in an ideal system, at any given time, a snap shot of a country’s amount of available money should not exceed the total wealth of the country by more than a few percentage points.
Or so says the theory. Reasonable theory that is.
The role of economic theory:
Even the above simplified example of a closed system is subject to a myriad variables that can affect the value of money. Think for example of the effect of droughts or floods on agricultural and/or mining production. Think of the breakout of a disease that may decimate the population. Think of the effects of bumper crops or a sustained drop in natality rate. These are all examples of things that would influence the “value” of money in circulation. Imagine if drought hindered agricultural production for two years. All other things being equal, this indicates that our fantasy country would be poorer. Therefore, in theory it should diminish the amount of money in circulation to reflect their new poorer status.
But what would the consequences be if the amount of money in circulation was not reduced?
Obviously, there would be more money in circulation but less produce available (less wealth). Therefore, produce is now more desirable because it is in short supply and everyone wants some. The corollary is that you may have money (tools) but there isn’t enough produce for everyone. Therefore the price of produce increases. To put it in a different way, in aggregate the tool you wish to exchange for produce has lost value. This is known as inflation. Inflation is the loss of purchasing power due to an increase of money and credit in the system.
The role of politics:
One of the characteristics of the Western democratic model is, to varying degrees, the market economy. That is an economy that is not state directed and that allows for the freedom of an individual to chose what to do at any given moment of the economic and political cycles: with whom to associate, what to produce, how to source funds, how to sell the product or service.
Measuring the wealth of a nation is notoriously tedious and fastidious work that has the annoying characteristic of inducing sleep in most reasonable people. But necessary work it is and governments employ brigades of bean counters and number crunchers with the odd sprinkling of economists and mathematicians to carry out the task.
The ostensible objective of politics is to create and increase the wealth of a society, to increase comfort and security and generally to just create an Alice in wonderland type of environment where everyone is educated, good, generous, affable… and rich.
But in order to deliver on promises, a politician needs money.
In the democratic system, society will tend to always vote for the politician that promises the greatest amount of wealth. I mean, when was the last time anyone was elected on a platform of spending cuts and general belt tightening? Even if a politician should be brave enough to go out and call a spade a spade, he/she wouldn’t stand a chance not just because the masses wouldn’t be happy to be told they have to tighten their belt but because an opportunistic rival would campaign on the opposite platform of achieving change by spending more in a more “targeted” manner.
No matter where you care to look, empirical evidence shows that we have lived in an inflationary economy for the best part of a century. Who here hasn’t heard that a hamburger and a soda used to cost $50c back in the 1940s? That’s inflation at work. That is the loss of purchasing power of the currency.
Therefore, it is clear that democracy is inherently and by necessity predicated on perpetual inflation.
And it couldn’t be otherwise. Politicians must always promise some sort of spending program or other initiative regardless of whether the wealth of the country increases or not. If this were not the case, then a burger and soda would still cost in the neighborhood of $50c.
The unholy alliance: when economics and politics come together.
As human dynamics go, none are as disruptive and pernicious as the alliance of economics and politics. I’ll hasten to say here that in aggregate, politicians are a far less educated (far more ignorant if you prefer) bunch than economists or, indeed, bankers. When I say bankers, I don’t mean Nicholas Taleb’s Fat Tony. Fat Tony is only a minion. He is one of the big cogs that earns unhealthy amounts of money through an overdeveloped predatory and opportunistic instinct but is woefully short on intellect and, indeed, woefully ignorant of history. Top bankers, the happy few that sit at the very top of the oldest and most entrenched banking institutions and whose earning stream is not only calculated in Dollars as Fat Tony’s would be, are patient and calculating strategists. Whereas Fat Tony’s power projects over decades, the power of top bankers projects over generations.
Essentially, top bankers only have one mission and one objective: make the central bank independent and under their control. Once their objective achieved, top bankers can sit back and let a steady revenue stream roll-in regardless of the state of the economy. But that’s not all! With a steady risk free income, they also get political and military clout. So whereas Fat Tony may earn hundreds of millions over a period of a decade, top bankers can earn billions over generations along with political and military power. And the best part of the set up is that they will never be seen as being implicated in anything.
It doesn’t take much to convince politicians to make the central bank independent. All a politician needs to know is that an independent central bank is the ticket to perpetual inflation and he’s sold on the idea.
An independent and private central bank such as the Federal Reserve is tasked with the responsibility to create the currency of a country. Private banks turn a profit by charging interest and fees. And this is where it gets interesting. The minute any Dollar bill leaves the premises of the Fed where it was created and is handed to the Treasury, it has been devalued by the prevailing rate of interest.
Think about that for a minute. Every single Dollar bill on its way to the real economy is instantly devalued the minute it crosses the door step of the Federal Reserve.
The implications of this simple concept are several. But the fundamental implication is that it is mathematically impossible to ever repay the debt to the central bank. That is; you could round up every single bill and coin in existence throughout the realm to return it to the Fed and you would still be out of pocket because you owe interest on the money you just returned.
Et voilá!! Perpetual inflation is guaranteed hence your hamburger and soda today cost $3 dollars.
Of course there is a snag. There always is. Like all dynamics, inflation too has a shelf life and a mathematical limit.
Inflation is not a bad thing in and of itself. Inflation is great at the beginning of a cycle. It is great to get things going. It is great to jump start an economy, for example, after the ravages of war. But like all dynamics, the use of inflation should be monitored and moderated.
But who are we kidding right? Once a politician has a taste of the wonders of inflation, he/she will never let it go. Worse still! When the economy succumbs to over-stimulation and hits the buffers everyone is under the impression that more inflation will set things right. And off they go making central bankers even richer.
We have established that a “democratic” system is inherently inflationary and we’ve established that inflation is the debasement of the currency as attested by a general rise in the cost of living (prices). I’ll say here that for similar reasons, a statist system too is inherently inflationary. But for the purpose of this discussion I’m looking at the Western model that has “prevailed” in the recent past. As an aside, one of the main factors contributing to the blow-up of the USSR in the late 80s, was the destruction of their currency.
“So what”!? You may ask.
So, by now you hopefully understand two basic concepts. First, that the bills and coins you have in your pocket or the money you have in your bank account have no intrinsic value at all – money is not in and of itself wealth. It is a medium of exchange; it is a tool that you can use to exchange for something of similar value like a watch for example. Second, that a rise in the cost of living (rising prices) is caused by the devaluation of the currency. That is because when the amount of money in circulation increases exponentially without a corresponding increase in wealth, we are destroying the currency.
At this point, a definition of what constitutes wealth might be useful even though it is an exercise fraught with controversy.
Adam Smith, dead as he is but still wielding considerable power in economic circles, defines wealth as:
“the annual produce of the land and labour of the society”
Thus, if we take Gross Domestic Product (GDP) which is the accepted measure against which most economic and finance metrics are compared, the debate hinges on a number of issues one of which is whether or not the service sector should be included in the calculation of wealth and, if so, to what extent. That is because in what is known as ‘post industrial’ economies (basically all Western countries) the economy has shifted inexorably towards the service sector (tertiary). Essentially, as society becomes more prosperous, it progressively outsources the more labor intensive tasks (i.e. Agriculture) and shifts towards tasks that are more intellectual (i.e. Lawyers and financial advisers). To wit, recent CIA statistics place the GDP of the USA at $10Trillion (twelve zeros) broken down as follows: 78% services, 20% manufacturing and 1% agriculture. The question here is: what part or portion of service can legitimately be considered wealth? I mean, if I take a handful of mud and produce a brick, the combination of the raw material (mud), my labour and a furnace that someone built for me produces an item that I can store and sell at a point in the future. But when a massage therapist has finished his session and takes a fee for his services, other than the presumed feeling of well being of the customer, what is there left tangibly? Can the customer in turn sell his feeling of well being to someone else? Therefore, although these two activities both contribute to GDP, the former could rightly be considered as having greater residual value than the latter.
So, if the economy of a country is 78% services, how much money should there be in circulation?
That is hard to say. What can be said is that regardless of the impact of the the service sector on the economy, money supply in the West has progressively far outstripped the progression of GDP thereby debasing the currency to within a few basis points of its mathematical limit. Of course, this last statement is going to make some of you roll your eyes but hey! We’re here to discuss things right?
For a bit of fun, you can see what a dollar amount was worth at different points in time. Give it a whirl.
And now, just to put things in perspective, I offer you a few charts. By preference, I’d like to use all Federal Reserve data (skewed as it might be) however, some three or four years ago, the Fed stopped publishing M3 data (broad money supply) because they feel it is obsolete and too costly to gather and collate… to which I can only say “whatever”.
Thankfully though, the guys at Now and Futures along with John Williams still think that money supply data is important and have set about collecting and collating M3 data along with a bunch of other very useful stuff on behalf of the authorities. To the team of Now and Futures therefore go our thanks and I can tell you that this web site is perused world wide even by the authorities themselves.
Lets start with a long term chart of US GDP nominal growth since the turn of the last century. I am sure you’ll be impressed.
Now just to temper your enthusiasm, the following is the same chart but expressed in year over year percentage growth.
This is the point at which we turn to the guys at Now and Futures for a peek at money supply along with a number of other interesting bits of info. Please note that time scales of the following charts are shorter than the two charts above.
M3 + Credit longer term chart
In the following chart, you can observe the relationship between money supply growth and GDP growth. What you want to look at is the relationship between Real GDP and M3 + 18 months. You will notice that whilst money supply grew at a healthy clip sometimes peeking at 18 and 20%, GDP growth has at best meandered between 0 and 7 percent.
The following chart is pretty much self explanatory. And this is what this rant is all about. You will notice that the correlation between money supply and inflation is fairly close if not in lockstep.
So there you have it. If your hamburger and soda today cost upwards of $3 it is because governments are devaluing the currency. So don’t let anyone tell you otherwise. Rising prices do not cause inflation. It is the other way around. Inflation devalues the currency; therefore you need more unit of currency to buy the same item.
NOTE – In copying my essay into WordPress, I seem to be unable to embed pictures in the text by simply copying and pasting. So I am pasting the url from which all the above charts are derived and you can scroll through them.
As stated previously, inflation is not an entirely undesirable dynamic. Inflation is useful and has a role in the greater economic scheme. But like all dynamics, inflation must be monitored, moderated and, eventually, must be allowed to subside in order to allow the economy to adjust.
As you may guess though, humans in general and the politician variety in particular can’t let go of a good thing and in their view where some is good, more must necessarily be better. And that’s where the cookie crumbles.
In view of the fact that it is certainly not a private central banker that is going to tell you to slow inflation, nor is the public going to ask you to moderate money supply, nor, indeed, is a politician going to restrain public spending, something, somewhere, at some point must give.
I’ll premise here and now that never since the dawn of man has anyone ever been able to repeal any social, political or economic cycle ever. Not ever. Everything has a beginning and an end. Human history is fairly well documented and no matter where one cares to look it is a matter of fact that humanity has lived times of prosperity and peace as well as times of penury and war. This is not a judgment as much as an observation. It is what it is.
Where we fail as humans is in our unshakable belief that we can prevail over our environment.
To be sure, humanity does win innumerable battles over the environment and an argument can be made to justify that we try. What is less clear is why when the obvious choice to win a battle would be to do nothing we feel that something must be done even at the cost of postponing the inevitable at greater cost later.
This is where expediency, corruption, greed and/or just plain ignorance and stupidity (mostly on the part of politicians and regulators) come into play.
To wrap it up:
So, what are the causes of the crisis that we are facing today? Stiglitz is not wrong in enumerating the reasons that he does. But that is not nearly enough to explain the how and the why we are where we are today.
Inflationary cycles are long. Inflationary cycles span generations. But inflation has a mathematical limit.
Typically, the final phases of inflation are characterized by excesses in all sectors of society, the economy and government. As the ostensibly beneficial effects of inflation wane, it takes an ever greater amount of credit to achieve the same result (i.e. GDP growth). This is a period of time where the prodigious amount of money and credit sloshing about in the system lead to accelerated consumption and investment, innovation in many sectors and military adventures.
One of the sectors that benefits the most from innovation is, of course, finance. Throughout history, innovative finance has lead otherwise sensible people to do spectacularly stupid things. By way of example, think of the South Sea Bubble , the Tulip Mania , John Law money scheme , and as if France had not learned its lesson after Law’s shenanigans, they went on to do a similar thing but much larger as you can glimpse here . In more recent times we have the Panic of 1873 , and, of course, the Crash of 1929
Through it all, innovative finance was credited with heralding a new dawn of human prosperity.
But for those that were willing to see it, the signs of idiocy and criminal behavior were everywhere. Today more than ever before, the public has, or could have, access to real uninterpreted information that could highlight potentially undesirable situations and outcomes. But the democratic cycle is such that we all chose not to see what is clearly an unsustainable situation.
To wit – inflation is not really a secret. I mean, sure, governments pick and chose the component parts of the calculation to publish a more benign figure. But if you can’t or don’t want to look for yourself, there are a bunch of independent professionals that could keep you informed of what is really going on. When only two years after the Enron fiasco Fannie Mae, a company that by itself props-up half of the US real estate market, was unable to publish its accounting books for a period of eighteen months, you would have thought that someone would at least wonder if there wasn’t something more sinister going on. When banks started using Special Investment Vehicles to keep investments off their books, nobody bothered to point out that it might not only be a bad idea to do so but that the legality is suspect too. When someone like Warren Buffet tells you that Derivatives are ticking time bombs, you would think that someone in government would at least bother to have a looksie to see what the old man might be talking about; particularly when the estimated value of this market is ten times the total value of the world economy combined. When a company like General Motors stops making money in its core business (that would be making cars) and is losing money on every vehicle they sell but are actually making money through their financing arm (GMAC), you would think that someone would try and force a reorganization of the business maybe?
We can sit here and throw out myriad examples of red flags that went up throughout the years and that nobody took notice of or chose to disregard as Greenspan did. However, when all is said and done, the fundamental reasons we are in this mess today are to be found in our banking and, by extension, monetary systems.
Like all dynamics, fiat money and fractional reserve banking are great in concept and are actually useful and desirable under certain circumstances and at given periods of time and at varying degrees of leverage. But again, sustained unbridled expansion of the money supply and leverage is what always and everywhere eventually kills the system because it invariably and inevitably leads to mal-investment, excessive production capacity, dwindling savings and a crushing debt burden.
THE CASE FOR WAR
So, we’ve established that a political system is inflationary by necessity, that inflation is the debasement of the currency and that the survival of an independent central bank (and of the political system) is predicated upon perpetual inflation. We’ve also seen that characteristic to open societies, the authorities and politicians have a vested interest in disregarding evidence of speculation and malfeasance as, to a certain extent, does the public particularly during the final phases of the inflationary cycle. Finally, we’ve seen how, as the inflationary boom progresses, the quantity of money necessary to achieve a rate of GDP growth similar to past growth is exponential.
If you’ve read any of my rants over the past two years, you know that I’ve been telling you that we’ve reached the limit of the inflationary cycle.
If my line of thinking is correct, you may wonder then, how I square my theory with the continued existence of the political system? Or the economic or social one for that matter? If our system is predicated on perpetual inflation and I am telling you we’ve reached the end of inflation, then what’s next?
A world war! That’s what is next. Or, at the very least, a war that will have severe and direct repercussions on the societies of Western industrialized countries accompanied by a systematic and severe drop in the standard of living and, quite likely, social upheaval.
“He’s lost it!” – I hear you say. Bear with me a while longer.
As proof of my contention I offer the following charts courtesy of the St Louis Fed.
In the above chart, we observe the capacity of our economic and political authorities to create money at a prodigious rate. As is plain to see, money creation has gone parabolic from around 1985 and has gone vertical in the past five months. But nominal values are not what really matters here. What is important, are percentage change values. Below is the same chart but in percentage change form.
Other than the fact that this chart too has gone vertical in the past few months, do you notice anything else of interest?
If one were to look exclusively at the two above charts, one could conclude that the inflation machine is ticking over nicely. But the devil is in the detail. Take a look at the next chart.
Drum roll please!!
Observe this chart. It tells you that the money that is being created, is not entering the real economy. Essentially, banks have reserves but either they don’t want to lend, or they cannot lend or consumers and business do not want to borrow or cannot borrow. The velocity of money is dropping and it has sunk like a rock in the past few months.
This chart is testament to my contention that it takes ever greater amounts of money to achieve a similar result. This chart represents the limit of the desired beneficial effects of unbridled inflation.
But if money is being created and it is not entering the economy, then where is it?
There it is. It is sitting in banks. And why shouldn’t it? At a time when banks are in shit up to their necks, the economy is unraveling fast, national and companies’ balance sheets are suspect and unemployment is rising why should banks take even more risks? Particularly, when the Fed offers them a “risk free” rate of interest on their reserves?
This is where it gets interesting.
Hopefully you remember from the first part of this rant that the fundamental implication of giving money creation authority to a private central bank is that in so doing you guarantee perpetual inflation. That is because on its way to the real economy, every Dollar bill created is instantly devalued at the prevailing rate of interest the moment it crosses the Fed’s door step. Therefore, it is physically and mathematically impossible to ever repay the debt to the central bank.
And here is the other less intuitive but probably more important implication of this concept: every Dollar bill created, automatically increases the country’s debt.
So, if it is mathematically and physically impossible to ever repay the debt, then the ability of the state to service the debt is predicated on its ability to devalue the currency.
Circular reasoning? Yes, absolutely!! The more money you create, the more debt increases. Suddenly devaluing the currency becomes a necessity of state. Therefore the state creates more money in order to debase the currency so as to decrease the debt burden.
Fine theory. And once again of course, there is a but.
Creating ever more money in an attempt to devalue the currency so as to simultaneously devalue the debt burden would be an ideal strategy if, IF, at the same time you were expanding aggregate wealth.
That is because money is not wealth; money is only a tool that you can exchange for wealth.
Think about it in personal terms. When you take a loan from a bank to buy a house, in an inflationary environment broadly speaking the value of your house will increase along with inflation. After ten years of inflation, the value of your house will be greater than the value of your residual mortgage. So, in this case, if you were to sell the house you could extinguish your mortgage and have some money left over too.
However, if you took a loan from a bank and used the proceeds on massage therapy, cars, holidays and restaurant meals, none of these items would have sufficient residual value to enable you to repay the loan.
So, in an economy that is 78% service based, the question of how much aggregate wealth is increasing in real terms suddenly becomes a vital concern.
That is because if aggregate wealth is not expanding at or near the rate of devaluation of the currency, you will reach a point at which inflation collapses, the debt burden goes ballistic and you don’t have enough wealth (assets) to sell to service the debt, let alone extinguish it. You are bankrupt.
Therefore, in an economic/political system based on fractional reserve banking and a fiat monetary regime, the functioning of the state and its survival are predicated on the perpetual devaluation of the currency through inflation. However, inflation has a mathematical limit at which point the debt burden overwhelms the economy. As deflation sets in, asset values crash, earning streams decrease or disappear, unemployment rises, consumption declines, inventories rise and debt can no longer be serviced. At this point, individuals, states and eventually governments become bankrupt.
This is where a question that many believe is unthinkable comes to mind.
As the largest debtors in the world, is bankruptcy a viable option for the USA and/or Europe?
That of course, is a rhetorical question. Of course neither Europe nor the USA can declare bankruptcy.
But if one or both should be unable to service their debt then what is the solution?
And this is when you realize that a war looms on the horizon.
Wars are great problem solvers. War destroys overcapacity and generates inflation. That is exactly what the doctor ordered. Civilian industry is converted to war industry, civilians are absorbed in the war effort and put to work or sent to the battle field and great amounts of cash are expended to sustain the war effort. At the end of the conflict you have geographic reorganization and depleted production capacity along with a dire need for reconstruction.
I will conclude this fairly long and by necessity lacking rant with one last chart.
The chart above is a monthly chart of the yield on the 30 year bond going back to 1980. As you can see, interest rates have been on an inexorable march towards oblivion. Manipulating interest rates, is one way for government to force inflation into the system. Essentially, by forcing down interest rates, governments force people to take their money out of their savings account and spending it. Low interest rates also encourage people and business to take loans. At the same time, dropping interest rates also mean that it is easier for government to service its debt. But low interest rates mainly help to debase the currency.
So, my parting thought is that soon unless the authorities are able to revive the velocity of money and credit to something resembling the rate of the recent past, we are in for a war that will have a direct effect on industrialized nations.
One more chart because I cannot resist.
Remember when everyone got their knickers in a twist because the S&P and the DOW made new all time highs in 2007?
Has anyone bothered to look at what was happening to the value of the Dollar when that happened?
Here it is. Since the first all time high of the S&P in 2000 the Dollar value collapsed. So the 2007 all time high wasn’t really an all time high when measured in Dollars was it. And imagine if you were a European investor. That would have been even worse. So, whomever should tell you that the trick to investing in the market is to hold long term, first ask them how long “long term” is and then do two things: first show them this chart and ask them if they know what inflation is and then ask them if they ever heard of Japan.
-The problem with deficit spending
… or, why is it a problem to consistently and repeatedly spend money you have not yet earned and may never do.
I have been asked why I think deficit spending is such a problem as well as why and how I think it is affecting you.
It seems to me there is a misunderstanding in what people think government is, how it does what it does and why. Particularly with regards to government expenditure, the electorate isn’t fazed by deficit spending as it is thought to be the natural state of the world. Government seems to be perceived as a distant and separate entity supposed to provide things for the public and although people perceive the word “deficit” as having mildly negative connotations, most don’t know what it means let alone what the consequences to themselves personally may be if any.
Definitions of “deficit” spending:
“Deficit spending is the amount by which a government, private company, or individual’s spending exceeds income over a particular period of time, also called simply “deficit,” or “budget deficit,” the opposite of budget surplus. “ http://en.wikipedia.org/wiki/Deficit_spending
“A term which refers to the situation wherein the government spends more than it receives in taxes.
The most evident consequence of persistent and aggressive deficit spending is the eventual inability of government to provide services such as pension payments, fire fighting, driver license renewal or mail delivery.
Today, particularly in the USA but in Europe and the UK too, there are numerous instances of greatly reduced government ability to maintain services to the public. Naturally, this is not an event but a process whereby services are progressively curtailed and/or eliminated as government becomes ever less solvent. Today, states such as California have already officially declared their inability to meet payments for certain services whilst CALPERS is fighting for survival.
So, what happened?
What follows ties in with previous essays. If you drink, pour a glass and settle in.
In an ideal world, government is nothing but the sum total of the aspirations, rights, obligations, wealth and moral duties of every household in the land. Government is a household composed of members of the households of the land elected by the people of the nation in order to act first as coordinator and regulator amongst them and, second, to be their representative to other nations. Administratively, legally and morally, what is true for a household is true for government. Thus, like a household, a government can only spend money according to its revenues and, just like you and me, any expenditure in excess of revenue must be borrowed.
So, the people of the land not only elect some of their own to become members of the government but they also agree to devote a portion of their income and wealth to finance government operations. Therefore, in its basic form government has no wealth or money and, like a child depends on its parents, it is totally dependent on the well being of the people of the nation.
If the people prosper individually, then so does government thus the nation. And it is never the other way around. NEVER.
The prosperity of a nation is defined by a large number of indicators such as infant mortality, average life expectancy, cultural and scientific achievements, technological innovation and of course, average income.
This is where things become fuzzy for most people and where the reality of government deviates from the reality of the life of individuals.
If you’ve read any of my previous essays, then you know that a political system, any political system, is inherently inflationary.
(Read my comments at the bottom of the article at this link: http://www.facebook.com/notes.php?id=534161490#/note.php?note_id=58899602592&id=534161490&index=2
There are exceptionally few people alive today that are born before 1913. This is a significant date only to the extent that it marks the inception of our modern monetary and banking systems. Since then, everyone in the USA, and gradually in the rest of the Western world and, now thanks to globalization, the rest of the world too, has lived in a monetary system based on fractional reserve banking and fiat money. What this means, is that you, me and two generations before us have lived in an environment where prices and wages have only moved in one direction: up.
For the vast majority of people on earth but particularly for people in the West increasing prices and wages is the natural state of the world. Few stop to think why that should be so, fewer still can contemplate a situation where prices and wages might contract.
But think about it! Broadly speaking an increase in population should lead to lower prices right? More people produce more goods thus the price of goods should decrease. Also, more people at work compete against each other thus lowering wages. Lower prices for goods and lower wages should theoretically lead to lower prices for things like cars, houses, insurance or education. But that’s not the reality is it. If you are thinking that the price of cars and houses increases because the cost of materials like metal and cement are increasing, you would be wrong. Material prices only flared in the past few years but the mining industry in general had been declining for at least twenty years prior.
So, something is clearly at work here.
That something is inflation.
As a concept, government is great. But government is made up of people. Specifically, government is made up of politicians. It doesn’t necessarily have to be so but the very nature of politics ensures that politicians will always prevail over, say, scientists. That’s because politicians are inherently and by necessity manipulators. As a necessary precondition for success, politicians must manipulate information, resources and people in order to achieve their objectives. Thus, politicians prey on people’s sentiments and desires and, of course, in order to do so, they need money.
However, considering the pervasiveness and ambition of politicians of all leanings, stripes and colors and considering the ambitions, not to mention the salaries, of government officials and considering the army, navy and air-force as well as all welfare programs and national infrastructure projects and all the research and development that goes on in the scientific and technological fields and the aid to poor countries and contributions to organizations such as the UN and sundry, one would be excused to wonder where all the money is coming from.
Clearly, if government spending was anything approximating their tax revenue, boosted as it may be by the same ratio of debt imposed on common mortals such as you and me, then it is evident that things like the moon landing, star wars or the atomic bomb or the Marshall Plan might not have been possible. Hence the perception that government isn’t really anything like you and me.
So how does government get more bang for its buck?
Enter the banker.
Whether a country uses a metal or fiat monetary system, you can always count on bankers to show you how you can get more bang for your buck. Like any system, a monetary system is as reliable as the regulators and guardians that manage it. Although harder to game, a metallic monetary system is as corruptible as a fiat one. However, subverting a fiat system has far greater and deeper consequences on society because fiat money allows infinite leverage and a high degree of stealth for the perpetrators of the deception.
Monetary systems are gamed through inflation. Inflation is the expansion of money and credit at a rate in excess of the rate of economic expansion which results in the destruction of purchasing power of the currency: i.e. more money chasing fewer goods. So, for example, a pen that might have cost $0.10 thirty years ago, today costs $1.00. This means that today you need ten times more units of currency to buy the same item. That is, your currency has lost purchasing power. Therefore, rising prices do not constitute inflation as is commonly believed. Rather, it is the loss of purchasing power of the currency that forces us to use more money to buy the same item.
Think of inflation as doping drugs; it turbo charges the economy by bringing future consumption and production forward in time. Therefore it can be argued that goosing inflation is desirable and, indeed, Monetarists and Keynesians are convinced that is so. Nonetheless, desirable as it appears, there are two fundamental problems with inflation. First, inflation must expand at ever greater degrees in order to effect the same result. The second problem is that there is a mathematical limit to the use of inflation past which, the system implodes.
(See previous essay “Thoughts on Stiglitz parts I, II and III the case for war particularly part III the case for war – http://www.facebook.com/home.php?ref=logo#/note.php?note_id=51874627592&id=534161490&index=18
The reality is that inflation does have its uses and can be desirable and beneficial at different times. However, inducing inflation artificially, aggressively and on a sustained basis over decades with no let up to allow the economy to adjust, will always and everywhere result in devastation and misery. Throughout history, you will find that inflation in one way or another was one of the greatest contributing factors to the demise of empires, national bankruptcies and, often, to world wars. It was so for the Romans, it was so for the Dutch (Tulip mania) and the French (Louisiana Purchase and John Law’s money scheme), it was so for the debacle of 1873 and 1920 and it will be so now.
(Some thoughts on government intervention and inflation – http://www.facebook.com/home.php?ref=logo#/note.php?note_id=58293127592&id=534161490&index=5
It is said that the Democratic system of government is not the best in absolute but that it is the best possible given man. (I still content that an illuminated dictatorship is better still, but that’s outside the scope of this discussion.) But democracy is inherently self destructive. That’s because the electorate will always vote for the representative that they feel brings them more material benefit (and as illustrated above, politicians are only too happy to oblige). Therefore, the democratic process is doomed to spend itself into oblivion. That is because no politician can ever be elected by proposing cuts and suppression of campaigns and projects. If anyone were foolish enough to attempt to campaign on a platform of austerity, rival candidates would opportunistically contend that change can be brought about without spending cuts (see Obama).
In order to effect change during a crisis without cutting spending, Keynesians contend that governments must pull out all the stops and spend prodigious amounts of money to kick start consumption and credit. Keynesians argue for deficit spending of nuclear proportions (the past fifty years have been dominated by Monetarist and Keynesian policies to various degrees in the West).
The problem with that line of thinking is that when you’ve been goosing the economy relentlessly for many decades and you’ve reached the mathematical limit of the beneficial effects of inflation, taking inflation nuclear is not only counterproductive but down right destructive. Keynesians are arguing that, this time around, an overdose will heal the patient… and world leaders egged on by Nobel prize winning economists seem to agree.
So, if such eminent politicians and economists are so sure they are right, how can little old me, with my high school diploma, typing away at my $800 computer know better? The thing is, I don’t. But to my credit (and their discredit) none of our leaders saw what a number of us knew was a freight train out of control already some years ago. Also, I can draw parallels with history and can look at data that other eminent folk have collated (folk that are not given the time of day in the main stream press) themselves drawing from smarter people still. What we see, is the diminishing effect of inflation on the expansion of GDP as attested most vividly by the velocity of money falling below 1 last November for the first time in many decades
and as attested by a score of other data some of the most relevant of which is summarized in this essay:
Hence my contention that not only have we reached the mathematical limit of inflation but that we are in that pesky period of time that goes from the decline of democracy to its eventual rebirth with a likely global war somewhere between now and then.
In essence, that is the problem with excessive deficit spending. Once again; nothing wrong with mild and occasional deficits. But this time we’re in for a world of hurt as country after country are going to curtail social services and public spending and, if not repudiate sovereign obligations on the basis of insolvency, then engineer a war.
Employees furloughed and services suspended
Making it harder for municipalities to set their rules for filing chapter 9
New York thinking about cutting city jobs
The little guys may yet stick one to the bankers (vintage rant Feb 07)
From my original Face Book ranting days…
The little guys may yet stick one to the banksters… for once…
Granted; the key word here is “may”. Nonetheless, the greed, the nonchalance and the arrogance displayed by our politicians in the recent past, abetted and enabled by the monetary authorities acting as so many puppeteers, may finally be reaching its logical conclusion and some little guys may, for once, actually benefit to the detriment of those blood sucking, immoral, opportunistic and devious breed of scum that are the bankers. Let me digress for a moment here to say that I am using the term “authority” rather loosely as the term denotes the right of enforcement through presumably superior knowledge and morality. As I am about to show, in this case neither knowledge nor morality ever played a part in the decision making process that brought us to this point.
Too, there is of course a wider moral implication to what may happen as this catastrophe unfolds in that the “little guys” that may benefit from this man made disaster may not necessarily have been in good faith when they ventured into the deals that may turn out to make their fortune. However, if for once the politicians and the banksters can be made to drink some of their own medicine, then I would be inclined to root for all those opportunistic and reckless individuals that thought they were smarter than those of us that adopted a more prudent and less bombastic approach to planning our lives and making a living.
I am talking, of course, about the ongoing real estate debacle that, of course, is no longer circumscribed to real estate because, of course, when you burden a complex system with ever increasing complexity you are bound to run into two of the laws that regularly and inevitably humble the bravest and the most audacious: the first is the law of diminishing returns and the second is the law of the failure of complex systems. Ok, so the latter is not actually a law but it ought to be because complex systems are prone to failure for the simple reason that when an outcome is dependent on an infinite set of prior outcomes, any disruption in the remotest part of the system will bring the whole thing to a halt. The other characteristic of large complex systems is that by its very nature, it does not allow problems emerge in a timely fashion. Therefore, until the problem is not evident, the system is still being fed and expanded so that when the problem does materialize, it backs up the entire system at exponential speed. Think of it as a pile up on a busy highway: traffic is flowing bumper to bumper and at increasing speed – one car slows down with the intention to come to a stop – the car behind sees the guy in front slowing down and begins to slow down too but, crucially, it does not realize the car in front is coming to a stop – the third guy in line slows down too and gets closer to the second guy – and so on and so forth. At one point, the second guy realizes the first car is stopping so he applies progressively more brake – the third guy is caught by surprise because the car in front is slowing down faster than expected and in turn applies more brake. But by now it is too late and the third car runs into the second and the fourth runs into the third and so on and so forth and you have a pile up.
This is pretty much what is happening now in the financial markets with the difference that on the highway the dynamic is linear whereas in the financial markets the dynamic is multi dimensional. But the problem is not strictly financial. Finance happened to be the trigger but it could have been as easily anything else that triggered the day of reckoning and the result would have been the same.
If your second brain cell hasn’t packed in and you haven’t yet glazed over, there is a chance you might actually want to know what I am going on about because I can pretty much guarantee that this pile up will impact our daily lives in a very tangible way. In case you have missed it, the effects are already felt and are all too real and this time there is no hiding for anyone anywhere. Everyone is in for a share of the pain and painful it will be.
Since I’m a nice guy and realize this has already been a long rant to read, I’ll cut to the chase. This is the article that prompts this tirade:
To be sure this is not strictly news. There has already been at least one case that I know of whereby Deutsche Bank had a similar problem in Ohio around November 2007 or thereabouts. The irony of course is that the banksters that devised what can only be described as a Ponzi scheme should have omitted to observe the very first law of accepting collateral against a loan; that is to keep the deed to the ownership of said collateral in a safe place. Serves them right and I truly hope that all those seriously stupid bums that naively threw themselves into the real estate market with purely speculative intent will prevail over the banksters.
Of course, my position is morally objectionable if for no other reason that I am rooting for those people that recklessly but willingly ventured into dodgy get-rich-quick schemes to the detriment of those people that actually tried to save and build a secure foundation for their children, their own pensions and society at large.
For the best part of the last fifteen years the banksters in collusion with the corporations, collectively known as the “Powers That Be” (PTB) have, through manipulation of the politicians, pillaged and ransacked society in a huge scheme aimed at transferring wealth from the common folk to themselves. And they have been rather successful I might add. As evidence of my contention, take a look at the level of savings in the West. If you don’t know where to look, I can tell you that the rate is very close to zero and, in the case of the USA it is below zero by a substantial margin.
If you don’t find this fact alarming then you have obviously not understood the extent of the problem. But that’s not surprising really because even some of the most eminent brains directly involved in the system admit to not knowing the mechanics or the ramifications of the system we have built. I say “we” because we collectively have allowed this to happen.
How we got here is at once a fantastic tale of creative deception and so blatantly transparent that nobody thought could be true and nobody bothered to check. The illusion is so complete that most people mired into a situation where they have to run faster and longer just to stay in place don’t realize what is happening. Everyone just assumes that is “normal” life. It’s what you have to do because everyone else does the same thing.
The truth is that most people are better versed in the life and relationships of the glitterati and more readily recall cool Hollywood one liners then they realize the predicament we are in. But whereas previous generations may have been faced with similarly difficult junctures, they at least had the advantage of living at a time when the socio/economic cycle was either growing or plateauing. Today, we are living in an end-of-cycle era. The upshot is that we are only about 15 years away from coming full circle. But the intervening years are assured to be characterized by political strife, economic hardship and war. I know you think this is not much of a prediction because there are already a number of wars in progress. I also know that you feel these wars haven’t really touched you from near and haven’t really affected your daily life. If you are reading this and you are an expatriate, you are probably feeling the effects of war more intimately because chances are you work in an embassy or an international organization. But considering how little you think this is affecting you, try to imagine how minimal the impact is on someone living thousands of miles away in Europe or the USA.
Give me some license here and allow me to just lay out what I believe to be the problems that brought us to this point along with some of the ramifications. As I am writing off the cuff, the reasons I present will not necessarily be in sequential order. I understand this may create some confusion but I haven’ the time nor the inclination to structure this rant in a cause-effect fashion. If you wish to discuss this further with me you can write back and I’ll explain in greater detail.
If you paid attention you will recall that I mentioned that we are living in and end-of-cycle era. Keep this in mind as we proceed. For practical purposes I’ll limit the discussion to Western society and to the period of time going from the Renaissance to today. You’ll be glad to know that I am only going to mention the renaissance because that is the seminal point in time when the centralized power structure of the PTB began to erode. Since then, society has been locked in a constant internal struggle where the PTB, civic structures, private enterprise and lay people fight for the acquisition of a larger slice of the power pie. The struggle can at times be armed but as we move in time towards the 21st Century and as the actors in the struggle acquired an ever more comfortable material and political existence, we prefer to shift armed conflict off our shores. Though necessary, war is still messy business and we’d rather not see it first hand. WWII is, after all, if not fresh than at least still vivid in most Westerners minds. The struggle for the power pie ebbs and flows as the parties to the struggle acquire progressively and in alternating cycles more power prompting their adversaries to come up with ever more ingenious strategies to take the power back and so on and so forth round and round we go.
And this is the beauty of the Democratic system. Churchill said that though by no means perfect, it (democracy) is the best we’ve got. Democracy is not perfect for the simple reason that it differs from Despotism in terms of size of the ruling body. Democracy is the imposition of the will of the many over the few. Despotism is the imposition of the will of the few over the many. But whichever way you slice it, you always have segments of society that are unhappy and, sometimes, oppressed; it’s just a matter of degree. Some of you will argue that Despotism is far worse because it also threatens the life of individuals for no particularly valid reason if not rule by terror and I would agree. But it changes nothing to the equation and, I would counter argue, in the end-of-cycle phase, Democracy can be pretty scary too. I’ll spare you the examples as I am sure you can think of a bunch yourself.
For the purpose of this discussion, the other key moment in the socio-economic life of the West would have to be the creation of the Federal Reserve in 1913. Although not immediately significant for the entire Western world at the time, the creation of what was and is portrayed as a civic structure tasked to regulate and smooth the ebb and flow of the economy would become the lynch pin of the financial and economic architecture of the world shortly thereafter. And here is the rub. A country that was born of rebellion against the ubiquitous and oppressive power of the state; a country that set out to build a society free to worship whichever God suited one, free to engage in enterprise and to acquire property; a country where citizens could freely settle where most suited them; a country that strives to achieve a system of checks and balances so that no one government or institution could act unilaterally; a country that set out to build the type of democracy that would be the envy of the world …. and they went and relinquished monetary power to a central institution with governmental ties.
In case you are not versed in the arcana of economics, there are two overriding concepts at opposite ends of the spectrum in terms of running a country: statism or capitalism. Statism was/is championed by countries such as the former Soviet Union, Cuba and to a significant degree still today China. Capitalism of course was championed by Western countries all be it in varying degrees with the USA considered the more extreme proponent. In simple terms, Statism in its purest form calls for fully centralized control of economic and social activity: i.e. The government decides what to produce and how much, what to sell and how much, how much workers will be paid, where people can live, where and when people can meet if at all, where people can study… you get the picture. Of course it was claimed that Statism failed and, as a consequence, the Berlin wall came tumbling down. In the opposite corner Capitalism advocates free markets and freedom of movement: i.e. Let people decide what they want to buy and how much, where they want to live, what they want to do or where they wish to go, with the State acting as a benevolent and non interventionist overseer.
Every country in the world falls somewhere in between those two extremes with the USA as the self proclaimed champion of Capitalism in chief.
And that’s where the cookie crumbles. How free can markets really be (markets intended as the full spectrum of economic activity and people in a country and not only the stock market) if the quantity and the velocity of money is not within their control? The answer to that question of course is that they aren’t. So, in the final analysis, relinquishing monetary control to a central power is tainted by shades of Statism especially if the people haven’t asked for that to happen.
At this point you are probably confused. “How”, you are thinking, “is it possible that the West or, worse still, the USA could be Statist economies? That’s obviously baloney because I know I can work where I want and I will be paid according to my ability and I can use my money to purchase what I wish and I am free to travel… “ and that is all true.
However, in terms of enabling the PTB to regain control of your lives, the creation of the Federal Reserve, and subsequently central banks in other countries, was a watershed and in one swift move the PTB took back a whole bunch of till then hard earned independence and freedom.
Right out of the gate, the Fed got to work on its magnum opus that was to be revealed in its full glory within the decade. By 1923 America had emerged victorious and energized from WWI and, courtesy of the Fed, was about to embark on one of the most legendary and still talked about social and economic booms of modern times: the 1920s or the “go-go” years. Without going into detail, the go-go years were defined by an “anything goes” attitude in society. Of course, anything went due to generous helpings of that miraculous lubricant called “money”. Money was readily available and cheap and banks couldn’t give it out fast enough. Nobody ever stopped to think much less ask where the money was coming from. And since nobody ever asked the question, the PTB through its enablers the politicians felt no moral constraint either. Quite the contrary; they gave out increasing amounts of money at ever decreasing rates of interest effectively handing out rope for people to hang themselves with. And hang themselves they did and what ensued was the first grand transfer of wealth of the modern era in favor of the PTB.
Money has been around off and on for millennia. In effect, money is the one and true weapon of mass destruction and so it has been in the past; always, without fail. Proof of my contention is in the fact that no currency has ever lasted in its original form over the ages. All currencies ever created by any society anywhere in the world have eventually failed and, when they did, they took away the possessions, the dreams and the life of the masses they were meant to help. Recent examples of defunct currencies abound. Before Zimbabwe, the poster children of failed currency management were in South America with Argentina holding a place of distinction. Zimbabwe or Argentina too exotic for you to wrap your head around? How about the Euro then. At some point in the year 2000, 280 million Europeans lost anywhere between 25 to 50% (depending on the country) of their purchasing power when their individual currencies were converted into the Euro. And in one swift, audacious and stealthy move, the governments of Europe slashed their obligations towards pensions and other fixed expenses that were already then detracting too much from the money they allot to themselves. That was move number 1 in what is the second grand theft of the modern era in progress as I type.
Currencies have always inevitably failed because in the particular case of money, less really is more. And although economists and politicians will know that, office and power can only be obtained with more money and the gullibility of the public. And democracy allows the PTB to create as much of the stuff as they wish and for as long as they keep feeding you the entertainment you want, you are gullible.
The modern concept of money is only about 300 years old really. Modern money is defined by money based on “fractional reserves”. Briefly, this means that the value of the currency that is in circulation is greater than the value of whatever that money is based on. Once upon a time, the value of the currency was based on gold. Today, the value of a currency is based on… well… the value of another currency… which, in turn, is based on the value of another currency… If you were already aware of this gem of trivia and it did not worry you, you probably have not fathomed the ramifications of the greatest pyramid scheme ever devised by man.
Fractional reserve money was first tried by a Scottish economist and financier by the name of John Law employed at the court of King Louis XIV (???) in France. Though brilliant in its beginning stages, fractional reserve banking quickly turns as it did for Law into a crisis and then a fully fledged debacle. Law was lucky to escape from France with his life in the end.
A man of keen insight, Thomas Jefferson born a few years before John Law would die, immediately saw through the scheme of fractional reserve banking and warned: “If the American people ever allow the banks to control the issuance of their currency, first by inflation, and then by deflation, the banks and corporations that will grow up around them will deprive the people of all property, until their children wake up homeless on the continent their fathers conquered. The issuing power of money should be taken from banks and restored to Congress and the people to whom it belongs. I sincerely believe that the banking institutions having the issuing power of money are more dangerous to liberty than standing armies.”
More than ever before, this warning should be heeded by all of you whom may still be reading.
We are living an end of cycle era. The PTB have hypnotized you and are manipulating you by giving you ever increasing quantities of ever more devalued money and increasing debt maintaining the illusion of wealth. You are working harder and longer just to stay in place. Simultaneously, the PTB distracts you with outrageous entertainment, tells you that it is your right and warns you that if you want to keep getting more of the same you have to safeguard this right by waging war to defend it against people that resent your life style.
I honestly believe the PTB have given out all the rope we need to hang ourselves and then some. And we’re sheepishly slipping the noose around our necks in the misplaced desire to appear cooperative and patriotic.
The carpet is about to be pulled from under us. The PTB has already picked up the side of the carpet and it is now in the process of lifting its shoulders as it prepares to raise its forearms for the final downward and forceful tug.
Proof that things are reaching a climax can be found in the whingeing and whinings of the banking and finance industry. After having lobbied so vehemently and fought so hard for deregulation and lessened oversight ostensibly to foster increased economic activity and abolishing the boom-bust cycle, today banks are calling for a government bail out for their reckless, immoral and criminal behavior of the past 20 years and, more specifically, for pyramid schemes they have designed, glorified and foisted on the public in the past eight years. They have made out like bandits and now that the Ponzi scheme is crumbling, they want you and me to pick up the tab and clean up the mess. The troubling thing is, of course, that they are likely to get their way.
“A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.
The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.”
So, yes, I am happy for those reckless assholes that willingly ventured in what they thought would be get-rich-quick schemes to keep their houses and for the PTB to eat shit on this one. But I know that even if that were to happen for some miracle, the banksters will come out of it all right.
We are living in an end of cycle era. The course is set for political and social strife and, very probably, a war or the expansion of one that is already in progress and that will directly affect all of us.
….. Hello?… Are you still reading?
The improbability of it all
“When you eliminate the impossible, whatever remains – however improbable – must be the truth”
There is no way I or any of the many people that see what is happening and have a modicum of knowledge of history, are smarter or more observant than the several dozen thousand officials, bankers and official pundits around the world. No way. That is not only a statistical impossibility but, if true, would also be a monumental cultural and historical aberration.
So, what is going on?
Western governments (I intend here government as a non descript entity with executive and legislative power as I am uncertain as to whom may want to do such a thing and why) are setting up and bringing about political and economic failure.
Plenty of evidence:
– Any superficial study of inflation and a debt based monetary systems shows the limits of said systems.
– We’ve been here before as recently as 1970 and many, many times before then
– The path to where we are today is strewn with red flags some as big as LTCM, then still bigger with Enron and just two years later a big-ass one like Fannie Mae.
– On one hand we need to recapitalize banks but on the other hand we are lowering interest rates?
These are just some of the more glaring absurdities and inconsistencies that cannot be reconciled by any theory social or economic it may be.
So, when you eliminate the impossible, whatever remains, however improbable, must be the truth.
We’re being set up for failure. The question is why.
The fundamental problem
Just to be clear, there are a number of fundamental problems but one in particular sits upstream from all others.
Mark to market rules must be enforced. These are the accounting rules that have been suspended so that banks may appear solvent.
Mark to market is that accounting rule that says that you should value your assets at current market prices.
We are giving Trillions to banks and offering Trillions more in guarnatees but are not forcing them to mark their assets to market.
This means that the likelihood that government giving money to the banks to buy their troubled assets at inflated prices is virtually guaranteed.
Till banks and others do not recognize the state of their balance sheet we cannot entertain the possibility of coming out of this crisis. We must remember that the Bank of International Settlements (BIS) estimates the value of derivatives globally at well over US$500Trillions. This is the elephant in the room that we must recognize and handle. Till we don’t do that, we’ll stay in this depression longer than we need to.
The debt dynamic: demand, production, inflation and deflation
Let me try this again.
Some of you have asked if I could clarify my assertion that: “The effect of debt is to bring forward demand and, therefore, production.”
That is because when a bank accords you a loan, you have an immediate lump sum of money to spend on something like a house or a car.
If loans did not exist, people would have to put money aside for a long period of time in order to buy a vehicle or a house. Therefore consumption would be slower and spread out over more years.
When the authorities devalue the currency and/or make loans cheap and easy to get, people are encouraged to borrow and consume.
More consumption brings more production.
This is the beneficial effect of borrowing money. It speeds up consumption i.e. It makes you consume today what you could only consume after many years of saving. More consumption needs more production. More production needs more machines, more oil, more electricity, more water, more wood and therefore more employees.
So, where is the problem?
The problem shows up mainly in two areas: with individual households and with industry.
– Individual households –
In exchange for a lump sum of money today, you agree to pay to the bank interest AND to pay all the loan back in the future.
This means that for some years to come you are dedicating a portion of your income to paying back the interest and the loan.
From that point, there are three stages.
The first stage is the period when the value of the things you are buying with loaned money increases over time and if at the same time your personal income increases too, you can secure more loans and therefore consume more. This is great.
The second stage is the period when the value of the things you bought with loaned money decreases over time (i.e. holidays, restaurant meals, shoes, clothes, cars, toys) but your income is still increasing, so you might still be able to secure more loans and therefore consume more. This is not bad.
The third stage is the period of time when the value of the things you bought with loaned money decreases over time AND your income is decreasing too. At this point you are not able to secure more loans so your consumption slows and then declines.
– Industry –
The situation for industry is similar to that of the individual households.
When loans are easy to get, consumption increases.
Industry must meet increased consumption with increased production.
The difference is that industry must plan ahead. Factories, hotels, condos, ships and trains take a long time to build or to expand. So when consumption increases, industry makes plans for the next five, ten or twenty years.
As individual households borrow more money and consume more, industry plans to increase production at the same rate or slightly greater. So they make plans for expanding production over the next five or ten years because they see a lot of demand.
However… this is one of the problems. Industry thinks that demand will be greater in five or ten years but they have not yet earned the money of that demand. So, if you don’t have the money yet, how do you expand production?
So, industry too must borrow money.
When industry borrows money, it starts building today factories that will satisfy present demand for ten years in the future.
For as long as households are in stage one or two, things are ticking over nicely. Towards the end of stage two things don’t look so good anymore.
By the time households enter stage three, industry is still expanding production but demand is collapsing.
At this point industry is in trouble mainly on two fronts. They have to pay interest on the loans they have taken from banks but their revenues are decreasing because consumption is decreasing. More importantly, now industry has huge production capacity that must be set aside because there is no demand. The problem with setting aside machines and buildings is that not only it feeds unemployment but the machines lose value and become old technology very quickly too.
To sum it all up. Easy monetary policy leads to increasing consumption and gives false signals to industry to ramp up production sooner than otherwise would be necessary. The resultant increase in activity also gives the impression of rising standards of living thus channeling ever greater amounts of money towards activities that do not contribute to wealth (i.e. holidays or shoes). The consumption capacity of a nation is therefore brought forward and compressed in time creating serious dislocations in industry and in the wealth structure of households (i.e. decrease in savings and wealth). When the chips are down, if households and industry are in trouble, then so are counties, municipalities, states and, eventually, the Federal Government.
At the point your income is no longer sufficient to pay the interest on the money you have borrowed, your only option is to sell your possessions in order to decrease the value of the loan so as to decrease the interest payment. This is the stuff deflationary recessions are made of.
My contention is that we’re now well into stage three. I say that in light of the fact that currencies have been inflated to a few basis points of their total devaluation. I say that because interest rates have been manipulated lower for the past thirty years and are today at the lowest level ever. I say that because the amount of debt required to maintain a semblance of GDP growth has reached ridiculous levels. I say that because savings are near zero in Europe and below zero in the USA. I say that because industry has no pricing power denoting falling demand. I say that because of gross industry overcapacity in anything but oil and agricultural production. I say that because the value of paper financial instruments far outstrips the value of any assets that have residual value equal to or greater than at the time of their creation. I say that because the velocity of money is falling despite an astronomical increase in bank reserves. I say that because Western governments are now printing money to buy banks, insurance companies, auto manufacturers, credit card companies, newspapers and any company they deem needs support and yet, companies are failing at the fastest rate in living memory. I say that because unemployment is soaring in Europe, the USA and China.
Finally, I say that because now that the tide is going out those that had been swimming naked are being revealed in all their glorious nudity…. The Emperor has no clothes after all.
The big idea
Some of my friends and acquaintances tell me that it is easy to criticize but what would I suggest we do as a nation and/or as individuals.
Here goes the list of what I propose not necessarily in order of execution. This list may grow going forward.
Stop the bailouts. Allow deflation to work itself out. Deflation is not the bogeyman and should not be feared. Deflation is actually desirable for those of us that have saved and are not burdened by debt. At any rate, why are governments so hell bent on taking us back to a situation of accelerating debt growth, accelerating price growth and depletion of natural resources? The question is rethorical of course.
Allow deflation to work itself out
Allow banks and companies to go bankrupt in order to allow the debt to be written off and good assets to be sold-on to investors and entrepreneurs that are still solvent
Maintain a reasonable rate of interest on deposits so that people that have capital left can park it in banks thus aiding capitalization and capital formation
If money should really be thrown at something then throw it at social safety nets. Public infrastructure projects come a distant second on my list of preferred entities to spend money on.
Reduce the size of government. Government does not generate profit. Government merely takes money from you and me (taxes, fees, licences…) and re-distributes it as it sees fit via public projects, the military, social security and aid. The larger government gets, the more money it sucks out of the economy. Government is famously inefficient at allocating resources because government projects don’t necessarily allow for a competitive bidding process and successive administrations keep changing their requirements necessitating endless work arounds and alterations in the middle of the game. Thus expanding government is a tremendous waste of money and resources. The expansion of government must inevitably bring about an increase in taxes (or fees, license costs, excise, duties… you get the drift).
I hear your argument. My proposed solution would bring about social dislocation and revolution.
We should not be where we are in the first place. Nonetheless, we are and this is the only way we can come out of it. The first rule to get out of a hole is to stop digging. The first rule to restart inflation is to allow the debt load to be paid off or written off. Inflation has a mathematical limit. Once at the limit, throwing more money at the situation only makes things worse.
Anyway, one thing that could be done to alleviate social dislocation would be to redistribute land for example. Instead of giving untold billions to the banks and to government cronies, give land to the dispossessed in order to settle them elsewhere and in order to increase agricultural production.
I reserve the right to alter this list as the evolving situation warrants…
Difference between a recession and a depression
“What has always distinguished a recession from a Depression is the stock market drop may signal a recession, but the collapse in debt signals a Depression.”
Banks, banks, banks, banks…
Save the banks, recapitalize the banks, buying bad assets from banks, get the banks to start lending again…. banks, banks, banks.
Notice how everything revolves around banks?
Now, if getting consumers and businesses to borrow again was really the crux of the matter, then why not take all this bailout money and set up brand new banks? There are literally hundreds of local and regional banks that are blowing up all over the place. Just take over the premises and start lending.
Think about it. We start brand new banks that could be very well capitalized considering the hundreds of Billions we are giving away and, most importantly, we own none of the toxic garbage. Nice clean capital readily available to go to work. The government could then start a very clean and efficient operation that will actually start making money immediately instead of at some imprecise date in the future. Consider this: the current capitalization of one of the presumably best banks still around and the bank that staffs the Treasury and Federal Reserve, Goldman Sachs, is 43Billion as per Yahoo finance. We are currently blowing upwards of 3Trillions with promises to backstop another 9Trillion.
Is that crazy or what?
After we set up a new bank, banks that have troubled assets and need capitalization may go to the new banks to try and sell some of their assets for cash and the worth and value of each transaction will be assessed on a case by case basis.
There you go. If there really were enough businesses and individuals ready to borrow, you could start lending again immediately.
Voilá… problem solved.
But restarting the credit markests is not the problem is it… ?!
A primer on how the stock market affects your life
I’ve read somewhere yesterday that President Obama said something to the effect that people should buy stocks. I meant to write something about the stock market aimed at the uninitiated so this is as good a time as any to do so.
Whether you like it or not or, indeed, whether you know it or not, the stock market affects your life and your material well being till you depart this earth. You may think that you have nothing to do with the stock market but you would be fooling yourself. If you have an address and you either rent or own the home, if you have a paid job, if you have medical insurance and/or benefit from social services, if you have children that go to school, if you have a savings account or if you pay into a pension scheme. In all these instances and many more too you are involved in the stock market. Incidentally, the above are exactly the reasons why all people around the world are involved in and tied to the fortunes of the US stock market. You may ask why?
That’s because if you are an American, your local, state and Federal Governments collect taxes from you in order to provide services. Your governments however, are just like you and manage their finances just like you manage yours; only on a bigger scale. Very often, governments local or Federal will use their income (taxes perceived) as basis for speculation in the hope of generating positive returns. For example; on the strength of their tax base, a County may issue bonds to investors so as to collect a lump sum today so as to use the money to build a project that is supposed to bring in a stream of higher revenues in the future. Essentially what they do is that they go to investors and tell them the following: our county or our state or our country has revenue of X amount of US$ per year – we want to borrow from you an amount of money and we’ll reimburse you over five, ten or fifteen years. Suddenly, as resident of a county or state, you are involved in the stock market and you didn’t even know it.
Around the world, the story is pretty much the same. Foreign governments perceive their income in exactly the same manner. Central banks, state pension funds, insurance companies, investment companies, entrepreneurs and individuals invest their incomes and savings in the market too. However, the US market being the most liquid and (one would have thought) the most regulated and transparent in the world, foreign entities invest the vast majority of their money in the US market or in US$ denominated assets. Oh yes! That’s the other thing. You may not know it but any country in the world may chose to issue US$ denominated bonds. So even if your life insurer tells you they are fully invested at home (say in Thailand) they might very well be invested in Thai government bonds denominated in US$ dollars. Et voilá! Suddenly not only are you involved in the stock market but you are involved in the US stock market and you didn’t even know it.
Hence the reason that most news I distill for you is US centric. Because we are all directly affected by what is said and done in the US and, anyway, the US economy constitutes 70% of the economy of the entire globe. So, what happens to America happens to us all.
Let me establish here an important distinction. The stock market must not be confused with the economy. They are related but one has little to do with the other. This is a very important distinction.
Let’s get to the point of this essay. Whether you know it or not, whether you like it or not, you are involved in the stock market courtesy of your government and/or civic institutions. As this crisis evolves, you may have read that municipalities, teacher pensions funds, university endowment funds and counties have been burned by playing fast and lose with their revenues. However, whereas Harvard is a private enterprise and the only people to be affected by the stock market losses their fund has sustained are the students and the contributors to the fund, in the case of a municipality or a county the entire country suffers. That’s because municipalities and counties perceive taxes in order to provide services to citizens. If that money is lost, services must be curtailed. Things like policing, garbage removal, water mains maintenance, road maintenance and so forth. And that, ladies and gents, is how you are involved in the stock market.
Let me go a bit further in things that may be of interest to you regarding the stock market.
Look at the chart above. The blue line represents the nominal value of the general stock market as represented by the Standard & Poor (I use the S&P because it has a wider breadth than the Dow Jones). The green line represents the value of the US Dollar. You will notice that I’ve placed some red and green lines that intersect red and green dots.
Essentially the best time to have been invested in the stock market in the past 30 years was the period between the two green lines going from spring 1995 to autumn 2000. That’s it. If you remained invested past this date on a long term buy and hold basis (LTBH) or if you’ve entered the stock market anytime between spring 1997 on a long term buy and hold basis (LTBH) till today, by several measures, you would have been and are underwater since a long time.
And here is the reason why.
The period going from spring 95 to spring 2000 was characterized not only by a rising stock market in nominal terms but also by increasing Dollar purchasing power. Those were real gains. But since then, the Dollar has tanked. So, whatever rise the stock market may have enjoyed as was the case between 2003 and 2007 was an illusion. The value of the US Dollar was collapsing. If you think that was bad enough for American investors, spare a thought for investors from around the world that must contend with the unpredictability of exchange rates. Interestingly, both Americans and foreign investors would have actually earned far more by staying out of the stock market and in cash Dollars during this latest decline than staying invested. Consider how devastating the nominal loss has been for pension funds, investment and insurance companies that have remained invested since summer 2008 instead of staying in cash Dollars.
As Japan has amply made clear in the most recent 18 years, long term buy and hold is not a winning strategy. At least, not in a world of fiat currencies and fractional reserve banking.
Obama is today suggesting that people should invest in the stock market. He may be right he may be wrong. I don’t know. What I do know is that we’ve now entered a deflationary cycle. If I am right, we can look forward to decreasing nominal asset values, decreasing revenue, decreasing earnings and, therefore, stock market values that are nominally lower for some time to come. Conversely, any debt you may be carrying at present, will proportionally become more burdensome on your income.
What you should take away from this essay, is that whether you are investing your savings in the stock market or not, the stock market still dictates your quality of life courtesy of your government. And if you are investing your savings in the stock market, it is not enough to look at the nominal value of a market. What you need to get your head around is also the value of the currency it is denominated in and, since you are at it, what the implications of a fiat monetary system and fractional reserve banking are on the value of your money and your wealth.
To see a whole bunch more charts similar to the one above, refer to the link “My charts” on the home page.
One more time hoping for clarity
I am having the hardest time making people understand the absurdity of our predicament and the inanity of the solutions we are applying.
Let’s start by reiterating that the US$ today is the reserve currency of most global central banks. Thus, what happens to the US economy and to the US$ affects us all to a very significant degree.
That being the case, you want to also keep in mind that the US economy is composed of 70% consumption. This is a fairly important consideration to remember throughout this essay.
First off, let me show you a chart of what is known as Long Term Interest Rates. Of course, we all know that in the West we ostensibly live in a society steeped in personal freedom and free markets. If that is the case, then someone explain to me how free can a market be when interest rates are set by an independent body that acts as it sees fit. If you have a hard time picturing why interest rates are important, think of it as the price of money. Since money is upstream of any human endeavor bar none, once you set the price of money, you are effectively running a command economy. But let’s not get ahead of ourselves just yet.
Look at the chart below. This is not my opinion. This is official government data. Interest rates have been manipulated lower for thirty years.
Manipulating interest rates lower means that, amongst other things, a government is willingly discouraging savings – in other words, governments are inducing the public to spend. But manipulating interest rates lower also has a myriad collateral effects. For example, corporations are induced to borrow money which not only allows them to invest in more capacity but, for example, also allows them to buy their own company stock. So, as a for instance, company X borrows 100 million at 8% and buys in the open market its own company stock. This may seem a harmless stunt and we’ll talk more about it later.
The rationale of lowering interest rates is that by lowering the price of money, individuals and corporations will be induced to spend more therefore creating more industrial capacity and hiring more workers, thus increasing the purchasing power of individuals, so inducing greater consumption thus soliciting more production…. rinse, repeat.
That’s the theory of course and it sounds sensible.
But here is one of the problems. Look at the chart of GDP progression year on year:
Despite progressively lowering interest rates, GDP progression only really bounced around 1% to 4% year on year. This means that even though we have encouraged people and corporations to spend progressively more, the effect of every Dollar spent diminishes over time. If by observing the two charts above you cannot see the connection, check out the next two charts.
The first chart shows GDP progression in absolute terms:
OK… that looks impressive. In the past 30 years, US yearly GDP grew from US$6Trillions to currently about US$14Trillions. So, we’ve more than doubled GDP over thirty years. To be precise, GDP is now 125% greater than in 1980
Now look at the following chart:
This is the chart of Federal debt in absolute terms over the same 30 years period. You will notice that government expenditure has grown from US$1Trillion to about US$12Trillion.
By my count, that makes an increase in government spending that is about 1100%
So, over thirty years, the US government has increased spending by1100% to achieve an increase in GDP of 125%
BUT WAIT!! That’s not all. So far we are only talking about government spending – i.e. the money government takes from you in the form of taxes (licenses, stamp duty, fees, VAT, inheritance taxes…) to spend as it sees fit for health care, the military, public infrastructure, covert projects and so on and so forth.
For a more accurate picture of the amount of money that has been spent, we must add the expenditure of individuals and corporations.
Here’s individuals’ expenditure:
I am unable to pull up a chart of corporate expenditure but Federal and Individuals’ expenditure combined already show the point I am trying to make. Combined, the Fed government and individuals account for well over GDP value. If you are wondering how that can be, you must keep in mind that not all Federal expenditure takes place within the borders of the country. However, any expenditure the Federal government makes overseas is supposed to bring back some benefit at some unspecified date in the future back to the country.
So, effectively individuals’, corporate and Federal Government expenditures have increased geometrically and still GDP potters about a 4% to 6% range year on year. Talk about running faster just to stay in place.
As an alternative measure to see whether what I am saying makes sense, let’s take a look at the following chart:
The above chart portrays the increasing financial burden on individuals over the past thirty years. The above chart is testament to the obliteration of peoples’ savings by intentional government mandate. If you don’t think that financial obligations of 19% of disposable income is excessive, you’ve probably never had to make a budget and plan your life. Financial obligations are only those expenses necessary to service debt (overdrafts, credit cards, mortgages, car loans…). On top of your financial expenses, you still have to factor in food, clothing, schooling, health insurance, utilities, transport and leisure for example.
So, today we are where we are. Great.
Now our governments are telling us that in order to get out of this crisis, we need to do more of what we’ve already done for the past thirty years. We must spend more; MUCH MORE… and we must give it to the banks first and foremost.
At this point, you may ask why not spend even more and keep GDP plodding about at 4% to 6% year on year? After all, things seemed to be all right till recently so why not carry on doing more of the same right?
If you remember the charts at the top of this essay, you hopefully remember, and now realize, the diminishing-effect nature of every new single Fiat Dollar spent.
The reason I say that doing more of what we’ve done in the past 30 years is now going to be counterproductive is this:
That there chart, is the Money Multiplier. Very succinctly, for as long as the MM is above 1, every Dollar spent has a multiplier effect on the expansion of GDP. That’s because every Dollar bill can be used repeatedly for several transactions. However, the nature of Fiat money is such that it conforms to the law of diminishing returns. The point at which the MM is below 1, even the geometric expansion of debt no longer stimulates GDP growth.
And that, is as clearly as I can explain the predicament we find ourselves in at present and the reason why I am certain that our governments will plunge us in a world war.
For more on Fiat money, do a search on my blog and you’ll find dozens of essays about it.
Of social development and tradition
It is uncanny how sometimes things can conspire to push you into doing something you had thought better of doing just moments before. And so it is on this gloomy and rainy day that I caught the BBC’s Doha’s Debates arguing whether Arab unity is dead or not.
Earlier in the day I had thought of writing something pertaining to the development of society and then abandoned the idea. But the BBC’s program sort of ties in with what I meant to write in the first place and so here go my two cents worth.
I was inspired to write about social development as I observed the living conditions of members of society living alongside the airport highway. This is by no means an unusual sight in the Middle East as large swathes of society are (by choice or necessity) still semi-nomadic and numbers of them may even set up their tents well within the city borders and take their sheep to graze in the midst of city traffic. However though not unusual, the sight of a makeshift tent and its rickety sheep enclosure located on a muddy clearing right on the border of the capital city on a rainy and gloomy day did prompt some thoughts on what development is, should be or could be. Everyone has an opinion on what development should be and how it should be achieved and since I have a blog, I can lay out what I observe, what I believe is happening and what I believe should be happening.
I’ll start in reverse order with the BBC program. Tim Sebastian put together a weird panel of people whose credentials were apparently appropriate but whom were either barely articulate or unable to identify and stay on subject or both. The question was whether post Gazza 2008/2009 Arab unity is dead and buried. Of the four panelists the panel in favor of the motion was composed by a Palestinian scholar with an American accent whom should have been articulate and gave the impression of being so and one former Qatari ambassador currently on a doctorate of law stint in England that could not string a coherent sentence together. The panel against the motion was composed by journalist Kuttab whose argumentative ability appeared weak on this occasion and a Saudi businessman whom though unable to build strong arguments was the person that made more sense. Tim Sebastian of course was playing devil’s advocate with both sides. By the end of the program, the motion was carried 77 to 33. That qualifies as a land slide.
Through it all it was clear that there were significant differences in the definition of “unity”. Kuttab argued that the advent of Arab satellite TV was a sign of Arab unity. The former Qatari ambassador claimed that the absence of democracy was a sign of the lack of Arab unity. The guy with the American accent reading from prepared notes launched in a anti capitalist anti imperialist tirade and essentially argued there was no unity because Arab leaders are corrupt. The Saudi businessman did say something but for the life of me I can’t remember what he was on about. But he didn’t say much throughout the proceedings hence my decision that he is the one that made more sense of the lot. Questions from the audience weren’t much better either. One brave Egyptian soul had an emotional outburst ending with essentially a question-statement (in the rhetorical tradition) of how can there be Arab unity absent freedom of speech in his country.
When Tim Sebastian asked the panel in favor of the motion what concrete actions they would consider appropriate in order for them to declare that Arab unity exists, they waffled. When Tim Sebastian asked the panel against the motion what concrete actions they can point to in order to show the existence of Arab unity they waffled. What I took away from the program is confirmation of what I observe in daily life in the Middle East: confusion and uncertainty. Confusion at all levels and in all aspects of life; social, economic and intellectual and uncertainty about the role, duties and rights of the individual in a society where the concept of the individual is still not fully contemplated outside the broader context of the extended family.
In essence, the BBC’s program highlights the fundamental issues that characterize the difficulties in developing a society. Development is defined by procedures and parameters that are by and large Western in concept and design. But whereas the measurement of the parameters can transcend culture, the procedures to attain those same parameters cannot; or it is preferred that they do not. That is because “development” in the Western sense necessitates a significant shift in culture and tradition akin to the shift Western society underwent at the beginning of the modern era. But this type of shift can only come about by altering traditional social and cultural frameworks that otherwise circumscribe those inherently human characteristics that, when set free, bring about innovation in the form of change: change of the power structures essentially.
For better or for worse, the concept of development at the global level hinges around the same core issues: reduction in infant mortality, reduction in the incidence of infectious diseases, availability of clean drinking water, alphabetization and so forth. The rationale is that if we can make people survive the first 15 years of their life and we can teach them to read and write, then they should go on to do things to improve the living conditions of their communities and, eventually, become productive members of humanity. However, empirical evidence shows that the track record of sixty years of aid and development is at best spotty. I believe it is fair to say that this is partly due to the fact that few leaders have the conviction or the political will and courage to tackle the traditional social and cultural frameworks that hinder the progress of development as intended by the political leadership.
Tradition is a double edged sword. Tradition is what gives a society its identity and its history. It gives it depth, texture, color and meaning. But tradition is also an anchor. Doing the same thing, at the same time, in a given set of circumstances and for no other reason than it has always been done like that, is not conducive to creative thinking nor, indeed, to developing a sense of personal responsibility. Furthermore, it diminishes the ability to think in abstract terms. Tradition is also closely related to ideology whereby belief supersedes and supplants inquiry, critical thinking, innovation and, once again, stunts the emergence of the concept of personal responsibility.
Attempting to color development programs with tradition inevitably brings about a crisis of identity that can overwhelm progress and, sometimes, stop it dead in its tracks or can create other important social dislocations such as disenfranchisement even though unintentionally.
The fact that the panelists and the audience on the BBC’s program were resentful but unable to frame the issue and point to concrete actions and results that would confirm or refute the motion is testament to the duality that developing societies must contend with. On one hand by a process of comparison they see what is missing but on the other hand they are unable to formulate and crystallize concepts and procedures to bridge the difference.
Undoubtedly some of you armed with reams of statistical facts and figures will point to the success of various development programs as have been undertaken by sundry agencies and I would agree with you. Sixty years of aid and development have indeed brought about some change. However, we can debate whether the change that has been achieved is for the better. Africa is a particularly sore point. To wit, it can be argued that development has been very successful in dramatically reducing infant mortality and extending people’s life span. However, the increase in the population has not been accompanied by increased agricultural production or entrepreneurship needed to sustain it. Part of the reason is because although greater numbers of the population are healthy, live longer and may be able to read and write, nobody has thought of tackling those traditional frameworks that would liberate the attitude required to become a contributing member of humanity rather than a contributing member of the family.
Similarly, leaders must concede that development cannot only be imposed from above. To mandate that each classroom should be equipped with a computer is a commendable idea. But in the absence of cultural change, a computer is merely a tool that allows people to do the same thing only faster.
Ataturk was way ahead of his time. Ataturk was ahead of any number of Western thinkers or leaders. In my opinion, until a whole bunch of new Ataturks emerge across the developing world, most developing societies are destined to merely follow at some distance behind the developed world with little hope of ever being able to shape their own destiny. Failure to tackle traditional social frameworks inevitably also brings about a sharp division between rich and poor. This of course is an issue that plagues developed countries too but the contrast and incidence is much sharper in developing societies.
Of gloom and thinking positive
Very often I am asked why I shoudl always be so negative. Clearly there are some very positive things I could see and write about.
Clearly there are. For one, we are alive.
The other thing I can tell you is that there is light at the end of the tunnel… though we cant see it yet, it will be there. The good thing about this depression is that when we’ll come out the other side, we will enjoy a renaissance in the proper meaning of the term. Society will have been chastened and will emerge with a renewed sense of morality, respect, tolerance and duty and will be eager to rebuild what will then be perceived a more positive future. The cost of living will be once again reasonable compared to wages that too will be reasonable. Our children will be able to attend schools where teachers will once again have earned the respect of parents. Agriculture will once again employ large numbers of young men and women as will manufacturing. In developing countries, women rights will move ahead to a significant degree.
In short, once we come out the other end of this bloody mess we can look forward to what some would describe as a more “wholesome” and meaningful life.
But our concern righ now is how to get there in the quickest possible way. And let me tell you. Our leaders are doing nothing today that has not been done in the past and that lead inevitably to extended depressions and, often, war.
But that is the nature of politics. At a time when the thing to do would be to do exactly nothing, politicians must be seen to be doing something. That’s because it is the nature of politics; it is partly opportunism, partly manipulation of people’s sentiments, partly ignorant conviction and partly misguided but honest fiduciary duty, all be it a very small part of the latter.
The technical difference between a recession and a depression is that in the first instance the economy and the stock markets may weaken for a time but in a depression it is the credit market that implodes. Guess which we have now.
At any rate. The amount of money we are borrowing and “spending” is gargantuan. The trouble is that this money is given to the same entities that have brought about this mess. So, instead of using this money to either prop up viable companies, strengthen the social safety nets and eventually starting brand new banks unencumbered by toxic assets, we give it to failing companies thus reducing market share for all, we give it to banks that are creaking under the weight of their failed bets and, more absurd still, in order to manage this galactic pool of dosh we hire the usual suspects that play musical chairs in the corridors of banking power and whom, by the way, did not see this crisis coming.
I’d like to sound more positive and tell you like Mervin King told you yesterday, that next year we’ll be back up and running like it was 2007. But I ask you: was the period between 2000 and 2007 really so great for most people other than the folks in the finance and legal industries?
Is real estate a good deal yet?
I was at a brunch last Friday and the conversation inevitably turned to the current global recession. To be more exact, this group of people had experience of the UK.
It appears the speed and depth of the devastation apparent in England have induced relatives of some in the group to fantasize what deals they could pick up right now in real estate if only they had some cash available.
Purely from the point of view that “deals” can only be had in anything provided few people know about it, I’d say the depression in the UK real estate market has some more time to run. In my opinion a few more years.
Essentially, bottoms in the price of anything are reached once enough people have been sufficiently burned to declare in public that they will never get caught buying the same thing ever again. When secretaries and the proverbial shoe shiners will suggest staying away from real estate because it will go a lot lower, or when talk at cocktail parties will revolve around the percentage of further loss in property values estimated by the interlocutors then we will have reached the trough of the cycle. Not before.
Right now, we are nowhere near that stage of common “wisdom”. Right now, we still have too many people gawking in hypnotic wonder at real estate prices they perceive to be lower than two or four years ago and, still under the spell of the great fortunes some appeared to ammass in the recent past, are left in a state of heady disbelief at the “chance” they seem to be missing out on.
Housing is not a good “deal” yet.
Is government almighty?
I was at a dinner the other day mingling with a good number of expatriate managers, diplomats and business people and as it happened, I got into conversation with a person whose economic literacy is fairly high and certainly much higher than mine.
The short version of the story is that my interlocutor firmly believes that a government and specifically the US government can produce inflation at will. If you’ve read any of my rants, you’ll remember I stated that government cannot function in the absence of inflation.
Of course most of you know I am not a formally trained economist. Those of you that know me well also know I am not formally trained in anything other than Quantitative Pontification. But I digress.
If confirmation were ever needed, the opinion expressed by this person confirms the ideas widely held by the public and our respective leaders that governments are omnipotent and can prevail over human and natural cycles. Of course, the fact that history shows this notion to have been bogus time and again in 7000 years of human history bears no significance in this our “modern” advanced world.
And this is where human arrogance spoils the party. We often forget the world has been “modern” to every single person that lived before us. Every era heralded as “new” promises the perpetuation of some ostensibly desirable social and economic framework brought about by modern inventions and theories. And every era thus heralded punctually succumbs to its inherent and inevitable natural cycle. Oddly, people can more easily envision how today’s world will be perceived as old in the future but have great difficulty imagining how the world of the XVI century for example might have been modern. But it was.
I suppose that as a liberal professional (I am using the term very loosely here) I along with a number of other people enjoy the ability to view an issue not in its direct cause/effect context but rather, we can view it in its natural environment as a dynamic that exists within the wider human and natural context. In other words, unlike specialists and professionals, we are able and prefer to look at human action and understand it as being a whole rather than a collection of individual parts. You could say ours is a non-mainstream Utopian touchy-feely leftish-tinged approach. A more scholarly definition would be praxeology or the study of human action.
For what appear obvious practical reasons, life and human action are arbitrarily divided and categorized. We have devised things like economics, science, literature and history and we’ve further divided and categorized those into things like monetarism, nuclear physics and modern history further slicing and dicing those smaller categories in more pointed categories still. Of course, as our knowledge of the smallest parts of a field expands we further subdivide each and every new field in more specialized disciplines seemingly ad infinitum.
And therein lies the rub because by necessity, the more our knowledge of the infinitesimal expands, the more we lose sight of the bigger picture. I think Descartes was thought to be the last man to know the entire body of knowledge known to man at the time. Since then, human knowledge has expanded orders of magnitude thus overwhelming our mnemonic faculties and leading us to specialization. Hence the reason why academic learning is compartmentalized and specialized.
Specialization is not a bad thing. But specialization does foster in the specialist a very high degree of certainty. Like Nicolas Taleb said: “A specialist cannot contemplate not knowing”. As a corollary to Taleb’s assertion, someone else said that a person cannot understand a problem when their livelihood depends on them not understanding it.
And that, in a nutshell, is what is afflicting us today. It is our unwavering belief that what we have discovered, learned and created today is unprecedented and that we can overcome the human and natural cycles that have afflicted society till very recently. It is the unwavering belief that we have entered a new era equipped with a knowledge and a technology that guarantee prosperity in perpetuity. It is the unwavering belief that government will always and everywhere come to the rescue of society.
A cursory look through any history book you care to look through, tells you that is most emphatically not so. Quite the contrary! The weight of 7000 years of human history shows that regardless of what modern specialists may have come-up with in the past 100 years, all things come to and end good or bad as they may be.
As I pointed out in previous rants, humans do win a number of battles against natural and human cycles and it is right that we should keep trying to. But we haven’t won the war and we likely never will. The universe has been around much longer than humanity and it will outlive it too. We can certainly influence a cycle but eventually things have to work out the way they have to work out.
In a sense, I am advocating a deterministic view of life but really what I am trying to convey is that ideology is a dangerous and undesirable outcome of certainty. Ideology is a sclerotic view of life that, like the proverbial broken clock being right twice a day, can be appropriate at times but will inevitably lead to ruin when applied consistently till well past the point at which it is obvious it is counterproductive.
In a very round about way, I am saying that the person I was speaking with last night grew-up and lived in a period of time characterized by inflation. He, like many others, believes that to be the natural state of economic life and because he has never witnessed anything else, and although he may have read about the various instances of deflation, he believes things to be different today. Today, his thinking goes, we are in a new era and we have technology and means at our disposal that we never had before. Therefore, he concludes, deflation is categorically not possible.
At this point you may ask why I bother. I do because I truly believe we are reaching the logical conclusion of an economic, a social and a political cycles that happen to be coinciding in time and, if not recognized for what they are, will lead us straight into another world war…. unless we do something about it and I mean pronto. Human cycles have different lengths and life spans and it is a rare moment when their phases overlap. I believe we are living one of those phases.
Praxeology tells us that we cannot separate politics from economics because they are all the result of human action. I pointed out in previous rants that any ideological political system, be it statist or democratic, is inflationary. It doesn’t have to be so of course, but it is because the essence of politics is to promise more and better things to society. Politicians cannot promise to maintain the status quo if they want to entertain any hope to be elected. If things are going well, politicians must promise still better things. If things are not going so well, politicians must promise better things. Either way, politicians need money. Thus, politics is inherently inflationary because it requires spending.
Government is a construct. In an ideal world and ostensibly in the West, government is supposed to be the representative of the people. Government has no wealth of its own and is not a for profit enterprise. Government is merely supposed to crystallize the desires and aspirations of a society and to act as regulator between entities. To carry out the tasks that society charges them with, governments have two sources of funding: taxes and debt. If you compare government to your household, you realize that in theory government spending should be limited by the amount of taxes it collects. Namely, government can only borrow money to the extent that the tax intake allows it to service the interest on the debt. This is where I am going to cut short.
Essentially, when governments embark on excessive expenditures (deficits) they must boost tax intake AND manipulate interest rates lower. This is inflationary and it works for as long as the increase in debt can foster an increase in GDP which in turn generates more tax intake.
However, there is an inflection point at which debt must expand exponentially to achieve a constant rate of GDP expansion.
Once interest rates are approaching zero and GDP growth is stalling government has a problem. At this point, it would be A BIG PROBLEM actually.
That’s where we are today. Governments in Europe, UK, USA and Japan have manipulated interest rates to virtually zero, are borrowing unprecedented amounts of money and yet, GDP growth has gone negative in real terms.
This is better known as bankruptcy. That would be TOTAL bankruptcy.
Once GDP growth is negative globally, it will be difficult to restart inflation anywhere in the world including the USA. Having artificially induced inflation in our monetary system for so long and at such a fierce rate, we’ve brought forward in time a prodigious amount of industrial capacity that will require many years to be absorbed materially and in terms of employment. This can be nothing but deflationary. At this point, printing more money to buy your own debt (monetizing debt) is the final nail in the currency coffin.
Of course this type of situation has happened before. It has happened in the ancient and the modern world. So, this is not new; it is not unprecedented; it is not different and it will end the same way. If anything is unprecedented, it is the sheer amount of sums that are being tossed about by governments in the mind boggling belief that what is causing this crisis can also solve it if only more of it can be thrown at the system.
Here I’ll go off on a tangent for a bit of trivia. In all the monetary, economic and political crisis of history, I suppose the award for originality must go to the Dutch whom not only successfully peddled tulip bulbs to society across the then known world but also whipped people up into such a frenzy that made the .com bubble look like a female bikini-model charity auction in jail in comparison.
The debasement of the currency is the one leitmotif common to the more notorious crisis of empires and countries throughout history. If zero interest rates, negative GDP growth and unbridled money printing do not signal total currency debasement, I don’t know what does.
The outcome is scripted unless we the people do something about it immediately.
What you can do of course is to remonstrate in the strongest terms to your representatives that state intervention is not desired. You can tell your reps that if money must really be given to private companies then it should be given to those businesses that are solvent and viable. You must tell them that if they really want to spend money on something then they should beef up the already existing social safety nets. You must tell them that excessive debt is not always desirable and that we now must protect those people and companies that still have capital left and a viable business model so as to shorten this crisis. If you really want to push the boat out, you could buy gold and silver bullion. Buying bullion is as close to a bloodless coup as you can get. Bullion is anathema to a debt based monetary system like the one that has been foisted upon us for the past 100 years. Finally, you must tell your reps that if they want your vote they must straighten out and read up on some history before they blindly pander to bankers.
But hey! We can dream no?! The truth is that politicians need bankers and bankers not only thrive on inflation but their livelihood depends on not explaining what the repercussions of inflation are.
Inflation or deflation?
Ya’ll know I am squarely in the deflation camp till some indicators, of which the Money Multiplier being at the top of the list, turn up.
However, here is another thought.
Purely from the point of view that the market tends to screw the most people, the likelihood of renewed inflation is minimal. That’s because if we did get inflation going again, the debt burden of most people would be lessened or extinguished. Also, restarting inflation depends largely on finding another asset class to inflate. So, till then, that’s not happening…
Deflation on the other hand, ensures that most people will be on the hook for many years to come.
NB: for a refresher on what inflation is, read my recent “Thoughts on Stiglitz”
Inflatioin has a mathematical limit
Money is upstream of any human event bar none.
Short of returning to barter with the ramifications that would entail, there is no alternative to the use of money.
However, since the advent of modern times (since the 1600s that is) we’ve gradually moved towards a more pervasive use of a variety of money called Fiat. Fiat money is merely a tool for exchange, it is a vehicle. Fiat money is not wealth in and of itself. Fiat money is only something you can exchange for wealth.
If you had one million Zimbabwe dollars in a bank account in 2000 and left it there untouched, today that money couldn’t even buy a tomato … if you found a tomato to buy in Zimbabwe that is.
If you had one million Italian Liras in a bank account in 1999 and left it there untouched, in 2000 you would have received five hundred Euros in exchange for your deposit. Although better off than in Zimbabwe, you would have immediately realized that five hundred Euros allowed you to buy only half of what the Lira did.
If you held one million Pesos in an Argentine bank in 2000 and did nothing with that money, by 2002 your savings would have allowed you to buy only one quarter of what you could buy originally.
In the past four hundred years, fiat currencies have come and gone with amazing regularity. From the French Assignat to the American Continental to the German Mark fiat money will disappear. It can self destruct as was the case for the Continental or the Zimbabwe dollar or it can voluntarily be withdrawn before obliteration by the monetary authorities as was the case for the French Franc and the Italian Lira.
So, fiat money is only a vehicle. You better not believe it is wealth.
Money is the life blood of any and all human endeavors bar none. It is the medium that allows human activity to take place at many levels and betwixt several parties simultaneously. Not that there is anything wrong with barter of course. It is just that the dynamic of exchange brought about by barter cannot even approximate the depth and complexity that money permits.
At this point, you may think that the crux of the science of economics and finance would be to devise ways to preserve the purchasing power of a currency… and you would be spectacularly wrong.
The reason we’ve moved from value based currencies to fiat money is because the institution of power within a society must be free to manipulate the currency in order to pursue what is perceived to be their “legitimate” raison d’etat . It cannot be otherwise. If that were not so, then we could make do with some type of currency that derives its value directly from the underlying economy. In a metal monetary system for example, the monetary base can only be expanded by employing people, machinery and time in order to locate, extract, convey, refine and distribute more metal. Thus in a metal based monetary system, the monetary base can only be expanded by expanding the underlying economy. But a fiat monetary system has no similar material or temporal constraints because the money is created by political decree without any reference to the economy. Sure, politicians and bankers fall over each other to show that monetary policy is sensible and grounded but empirical evidence shows otherwise. A typical case of being better off by watching what they do rather than what they say.
Thus, although a fiat monetary system is more flexible and, in theory, more adaptable, when coupled with a “Democracy” the combination is certain to, eventually, obliterate the currency. Once again; there is no alternative to the logical conclusion of the combination of these two dynamics.
If you can get your head around the above, then it follows that not only is inflation necessarily exponential but it also has a mathematical limit. And here is why.
By adopting a fiat monetary system, a government implicitly chooses to artificially induce inflation into the system. Once you induce inflation the first time, you induce a rise in price level thereby inducing a rise in GDP. The amount of inflation induced the first time, will be modest compared to the gains in productivity and tangible wealth. However, if you now were to decide to no longer induce inflation into the system, the following year you would be taking away that portion of GDP that was induced by the first round of inflation. In so doing, you are compromising GDP growth. Of course, the chances that in a “Democracy” the electorate or the politicians should advocate a reduction in spending in anything is indeed as remote a probability as statistically possible. Therefore, the combination of fiat money and democracy will eventually obliterate a currency and, depending on other circumstances, will also bankrupt the state issuer of the currency.
The problem arises by the fact that as the years go by, the inflation component of GDP growth increases till it overwhelms the number. Somewhere along the inflationary timeline, countries become “service” based economies.
Once you are a serviced based economy, you know that any let-up in inflation will spell doom for GDP growth.
This is the point at which government has a vested interest in closing an eye or two on practices that initially may be considered borderline legal.
Thenk at some point along the inflationary timeline, closing both eyes on suspicious practices no longer suffices to ensure GDP growth. This is the point at which government has a vested interest in aiding and abetting blatantly illegal practices.
As of July 2009, in the wake of the Western governments unilateral decision to buy into private enterprises in Europe and America to avoid the failure of insurance companies, banks, automobile manufacturers or finance companies; our governments unilateral decision to ride roughshod over some bond holders whilst favoring others in blatant contravention to the letter of the law; our governments tolerance of the by now discredited rating agencies that have been caught in flagrant and blatant conflict of interest; our governments explicit desire not to disclose how public funds are employed; our government tolerance of clearly larcenous practices as banks and insurance companies pay astronomic bonuses to their employees in the face of a crisis that is variously described as the worse since the Great Depression; our governments tolerance and reliance on a restricted number of finance professionals that hail from one of the largest finance houses on the planet to manage key positions in economics and finance….
…you get the drift…
Towards the end of the inflationary timeline, economic activity no longer suffices to service debt; the point at which industrial capacity utilization is at an all time low; the point at which after an inexorable decline over 30 years the velocity of money has dropped below 1; the point at which after an inexorable decline over thirty years interest rates are at all time lows…. at that point, inducing more inflation may not help goose GDP growth any longer. If, at the same time, in an attempt to make up for lost revenue governments begin to not only print bonds but also print money to buy said bonds from themselves rather than from each other… at that point, deflation is virtually guaranteed….
If deflation has set in then the following is virtually guaranteed…
Declining consumer expenditure
Declining asset values
Tightening credit standards
Of course the above wouldn’t be so bad if it weren’t for one thing…
As more people lose their homes and their jobs and as governments must reduce spending on public programs, civil unrest is sure to follow. And if the condition persists, you can bet your bottom Dollar that governments will fall.
So, before that happens, those moral beacons that are Western governments will very likely not step up to the plate to declare how things are really like. That is very improbable indeed. What Western governments will do on the other hand, is what they have always done in the past… engineer a war. If I am right, this next war coming up will be something to behold.
I say we’ll have us a global conflict by 2013 or 2015 latest.
Inflation/deflation redux – the case for war
Humans reproduce. That’s a fact of life if you’ll pardon the pun. As humans become more numerous it is a good idea to put policies in place in order to provide for them. Till a few hundred years ago, man bartered. If you were a shoe maker you would barter shoes for bread, vegetables and clothing for example. Barter works fine but is not a flexible system. Enter money. Money allows you to assign a monetary value to the shoes you make. Suddenly, two things happen. The first thing is that now you are free to transact with many more people than before – i.e. under barter, if you wanted bread you had to barter with the baker. However, one pair of shoes might be worth ten loaves of bread. The problem is that you can only consume one loaf before all ten loaves go stale. With money, you exchange the shoes for bits of metal (money) with anyone that wants shoes. Then you can use a portion of the metal bits you received for your shoes to buy the one loaf of bread you require. The second thing that happens is that when everyone adopts money, all products and services will be valued in the same unit of exchange. Thus, the metal bits you exchanged for the shoes, allow you to trade for more than one product at the time – i.e. under barter, you have to give one pair of shoes to the baker for bread, then a pair of shoes to the grocer for vegetables and one pair of shoes to the tailor for clothing. With money, you exchange a pair of shoes for a bunch of pieces of metal. Then you can apply a few pieces of metal to buy one loaf of bread and the remaining pieces of metal can be used to buy vegetables. Suddenly, one pair of shoes allows you to trade with two different people for two different items.
Money is a fantastic medium of exchange. But money in and of itself is not wealth. Money gives you the means to acquire wealth but it is not wealth.
Humans not only reproduce faster than they die off but they are also predators. Therefore the number of humans increases. As humanity expands, so will the economy. In order to facilitate economic expansion the quantity of money must expand at the same time.
There are only two ways governments can use to ensure that the economy and money expand simultaneously.
The first method consists in tieing the monetary base to a commodity like a metal or salt for example. Although safer, this method does not allow for rapid expansion of the economy. However, absent a natural catastrophe like a plague, this method allows for milder recessions and depressions would be virtually unheard of. This is because in a metallic monetary system, the expansion of the monetary base requires to locate, extract, convey, refine and distribute more metal thus also feeding the economy. This is as close to a virtuous cycle as you can possibly get. But again, it does not allow politicians or scientists or researchers to have a brain-wave and initiate new projects rapidly.
The second method consists in creating money as needed. Thus, if for example a researcher should wish to start research on cancer, government could just hand him a lump sum of money immediately. Similarly, if government wants to build a new stealth super secret fighter bomber, they can just allocate a wad of money to a contractor. The rationale of this method known as “fiat” is that money is readily available to be allocated to projects in the hope that said projects will become profitable in the future and bring revenues many fold the initial allotment of money. Thus, politicians and entrepreneurs always get ahead of themselves allocating money to projects on the back of past projects that have been initiated and are meant to start making money as the new projects are launched.
And this, in a nutshell, is the problem. A metallic monetary system can only be expanded by employing people, capital, resources and time. A Fiat monetary system has no such cost or temporal limitations. In a Fiat monetary system, the government can decide to create any amount of money overnight at no apparent cost. Essentially, in a fiat monetary system, your objective is to ensure that the projects you initiate make more money than what they cost to put in place. The moment your projects run at a loss AND you have more loss making projects than money making ones, you are diminishing the value of your currency. So, in fact, though not readily discernible, the cost of a fiat monetary system is accumulated and kicked down the road.
As I pointed out in previous essays, government is not a for profit entity. Government is nothing more than members of a society that are elected in order to facilitate relations amongst all members of said society as well as representing them to other societies in order to further trade relations and cultural exchanges. Government has no wealth and no money. But government does have the means to enforce its will on society. This power to enforce is given to and enabled by society itself.
In order for someone to be elected to government they must promise the electorate to make things better. Whether things should be going well or not, a politician cannot hope to be elected to office without promising some sort of improvement or amelioration on the socio/political/economic stage. Hence, merely engaging in the political process requires money.
Thus, government requires money for its overt and covert activities as does the political process.
And here is a pop quiz.
If you are running a government or if you are a politician, which monetary system would you prefer to operate under?
Thus, government and politics are inherently endeavors that require the expansion of the monetary base. This is better known as “inflation”. This is so in a democratic regime as it is for an authoritarian regime.
However, whereas a democratic regime cannot escape the logical conclusion of inflation, an authoritarian regime (in theory) could. Indeed there have been a number of enlightened despots throughout history but their rule invariably succumbed either to hubris or to envious pretenders to the throne. The result is that other than the plague, inflation will inevitably bring about the downfall of a country or society.
If you’ve kept up so far, the inescapable conclusion of this dynamic is that government cannot exist in the absence of inflation as, indeed, can’t the political process or, at least, the latter would be greatly reduced.
And here’s the problem. Inflation has a mathematical limit.
Inflation is not a bad concept. Inflation does serve a purpose under certain circumstances because at the beginning of the cycle, inflation has a stimulating effect. Inflation turbo charges the economy bringing demand and production forward in time. High levels of inflation will consume great amounts of resources that would otherwise be consumed over a longer time period. Inflation is like adrenaline. And just like adrenaline, the pervasive, persistent and aggressive use of inflation requires ever greater amounts of inflation to obtain the same result. Inflation is the ultimate Ponzi scheme. In order to maintain a constantly expanding monetary base in the hope to maintain a constantly expanding economy, ever more people must be brought in to contribute. When you run out of people, the scheme collapses.
Few people will know or recall that the USA in the late 60s was experiencing what the entire world is experiencing today – bankruptcy. Bankruptcy was brought about by a then eye popping expansion of money and credit that far outstripped the growth of the economy from the 20s till the 60s. The scheme could have run a bit longer if it weren’t for the French that in the 60s suddenly decided they no longer wanted to keep Dollars on hand. The day of reckoning arrived when France decided they wished to redeem their Dollar holdings for gold. That’s the moment the music stopped. What saved the USA in the late 60s was their capacity to convince other industrialized countries to go on a Dollar based Fiat monetary regime and enhanced fractional reserve banking. Following the industrialized world, globalization then brought the rest of the world in on the scheme too.
However, today there are no more countries that we can bring in on the inflation scheme.
Inflation could be kick started if someone could find an asset that could fire-up the imagination of the public like real estate did in the past ten years, or the dot com era before that. Both the dot com and real estate frenzy are notable instances of what needs to be done in order to keep inflation on an expansionary trajectory. The dot com and real estate eras both denote enormous creation of money and credit but falling velocity of money.
And that is where the rubber meets the road. The velocity of money is something that most people will learn about in school. However, nobody seems to have bothered to look at the velocity of money in the past thirty years; at least not anyone that has any say in economic policy.
As Steve Keen brilliantly and very simply shows in this and other essays, in the West in general, money and credit creation have been on a steady increase for the past three decades expanding at a yearly clip of anywhere between 9% and, in some countries, 20% and going parabolic in the past ten years. However, GDP has sort of pottered about in a range between 1 to 6% yearly. This data point should have been sufficient for any reasonable business person or economist to realize that Western economic policy (such as it is) would have needed revising many, many years ago. But what should have removed all doubt from what is the inevitable conclusion of inflation, is the fact that despite all the frenzy, despite all the perceived economic expansion, despite the dot com and real estate frenzies… the velocity of money has been on an inexorable march towards oblivion for the past thirty years.
In November 2008, the money multiplier finally dropped below zero.
What this means literally is that despite the ongoing desperate efforts of our governments to revive consumption, the untold Trillions that are being created in currency no longer have a multiplier effect on the expansion of GDP.
Unless some bright bulb somewhere in some country finds a way to kick the velocity of money up the ass and sends it back rising sometime soon (and I mean in the next 18 months) we have a problem on our hands. We have a fairly big ass problem on our hands.
Where we are today.
In point 3 on page 8 of its December 2007 report, the Bank of International Settlements estimates the global value of derivatives at US$500Trillions. That is FIVE HUNDRED TRILLIONS
To put things into perspective, global GDP hovers around US$40Trillions. Many economists and finance professionals have said and will say that the 500T is only a notional value. However, considering that world GDP is a fraction of this notional value, toying with 500Trillions is not desirable under any circumstances. Anyway, since then, this debt mountain has proved that “notional” can become rather “real” very quickly. But what is more interesting is that as the logical conclusion of the inflationary cycle is reached, turnover in these credit instruments goes into overdrive.
Now; considering that in 80 years of priming inflation all we have to show for is exponential growth in inflation but GDP growth that potters about in the low single digits (greatly goosed by hedonic adjustments a sober explanation of which is here), you would think that someone somewhere would suggest that maybe, just maybe, more of the same might be counterproductive at this point???
Pervasive, persistent and aggressive inflation pumping over the past 80 years (we must calculate 80 years because as we have chosen to adopt the US Dollar as reserve currency, today we have to bear the cost of US monetary policy from the inception of the modern Dollar in 1913) has come full circle. Inflation has a mathematical limit. Once the limit is reached you must find new people to contribute to the scheme or you must find a new asset class to inflate or your must devalue the currency usually by introducing a new currency.
If none of those three things can be achieved, governments become insolvent.
An insolvent government can neither provide the services citizens have come to expect of the state nor, indeed, can it make good on its external debt.
However, a Western government cannot declare bankruptcy.
… if a Western government cannot declare bankruptcy and yet it can neither provide for its citizen nor make good on its external debt, then what… ????
Thus, unless someone can re-start the velocity of money, somehow, in some asset class, we are hurtling towards a world war.
Money Multiplier below one along with money and credit pumping in the face of a global debt burden estimated by the Bank of International Settlements to be 500 Trillion Dollars to be serviced by a global economy that was at one point worth about 40 Trillion Dollars spells war folks.
Keep an eye on the velocity of money via the money multiplier.