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The well established definition of madness

…is doing the same thing over and over and expecting different results.  Standing on the sidelines and seeing this slow-motion car crash unfold seems a bit like heckling a steamroller.  Nonetheless, the truth shall set you free and all that, so let’s examine the current proposed remedies for the economic malaise.

 

Well, on the one hand we have the usual suspects, Krugman, Bernanke, Geitner, Mervyn King et al. What do they make of the current situation?  More of the same please and this time let’s really have a good crack at it. 

 

We get the usual criticism of the non-existent austerity, then calls for more government intervention, cuts in base rates and pressing Ctrl-P on the keyboard of some central bank computer.  Thus the great and the good are now promising us QE3 in the United States.  They have only printed nearly $2 Trillion thusfar so we can hardly expect such trifling chump-change to have any impact apparently.  The ECB balance sheet is up more than 50% since 2008 and if they are to avoid bankruptcy, if any European country falls down watch for much, much more.  The Bank of England almost looks like a small player in this having printed only £375B (anyone think we’ve seen the last of this?).    

 

Realistically the kind of neo-Keynesianism advocated here died in the 1970’s. The theory went “if you have inflation, that is a sign the economy can’t produce enough goods and there is over-consumption and too much money chasing to few goods, so raise interest rates and taxes to stifle demand and choke inflationary pressure”  Anyway, if you still have a straight-face and haven’t decorated your computer screen with cornflakes it continues “but if there is unemployment and a slow economy, cut interest rates and taxes (the last bit tends to be forgotten) do some public-spending (never forgotten) and hey presto, all will be okay”

 

Well the Stagflation of the 1970’s destroyed this theory; killed it stone-dead.  Yet like some kind of George Romero creation, the zombie of Keynesianism still stalks the corridors of power.  There are basically two reasons for this; first Krugman and many a lesser known establishment economist runs a kind of intellectual cover for this nonsense.  The media swallow this dross more or less whole and so when the shadow-chancellor goes on TV and talks about the ‘cuts’ being ‘too-far, too-fast’ there are those who take him seriously.    

 

It seems like the mainstream media is an unofficial accomplice of the banking crime syndicate which is running/ruining our markets and economies. Nowhere is this despicable relationship more apparent than in its deliberate efforts to grossly misinform investors on the critical subject of risk.  Honestly, does anyone think it smart to keep money in bust banks that pay sub-inflation interest rates?

 

So who is advocating the alternate position?  Well not the government obviously.  No actual cuts are being made and they continue with near zero interest rates and QE.  Nor anyone much they let near a TV camera.  It is simply a case of looking for yourself on the internet or reading some of the excellent stuff Murray Rothbard or the Mises institute put out.  We can hardly be surprised by this.  What politician would say “You need less of me, less taxes and we also need to abolish the fiat magic money tree”  But at the risk of sounding all Fox Mulder ~ the truth is out there.  Sure there will be plenty of people to mock and ‘Scully’ you, but when this nonsense reaches its endgame, at least you can be prepared.  And what will that be?

 

Well the only trick in the bag of governments and banks is ‘stimulus’ via cheap money be it QE or low/zero* interest rates.  At some point, confidence will disappear in paper money and the government bonds that promise it.  As we can observe from many examples from history, money will become hot (i.e. people will want to hold goods not money).  Real interest rates will climb as investors disengage from bonds and pile into tangible assets (thus further stoking inflation).  Also the government’s ability to borrow will decline sharply as we have seen in Southern Europe already.  Thus serious inflation and really spicey interest rates.  I hate to sound gloomy and I wish it wasn’t so but the worst is yet to come. 

 

(*I discount ideas about negative interest rates.  If you want to kill your own banking system in about 14 days, this is how to do it.  Not even our politicians are that dumb.  Ditto price controls ~ I can’t imagine anyone thinking this is a good idea)

6 Comments

  1. jameshigham says:

    Links here – hope it doesn’t spam me:

    Insurance on the debt of several major European banks has now hit historic levels, higher even than those recorded during financial crisis caused by the US financial group’s implosion nearly three years ago.

    Credit default swaps on the bonds of Royal Bank of Scotland, BNP Paribas, Deutsche Bank and Intesa Sanpaolo, among others, flashed warning signals on Wednesday.

    http://www.telegraph.co.uk/finance/financialcrisis/8721151/Market-crash-could-hit-within-weeks-warn-bankers.html

    And:
    A Swiss-based bank credit specialist I’ve known for some time now insists that it is bank viability, not bonds, that’s kept the EU’s central bankers chained to their Frankfurt desks.

    http://hat4uk.wordpress.com/2012/08/28/ecb-spain-stand-by-for-the-big-guns-barrage/

  2. Edward Lud says:

    I can’t see that inflation or deflation are, in and of themselves, bad things. They are just signals to the market for more or less supply. The problem is the retouching of the currency by relentless printing of it, that leads to inflation irrespective of whether there is too much or too little supply. Or is that a statement of the blindingly obvious?

  3. Jamie says:

    I have 2 questions please, surrounded by a few points of my own:
    1) Your point about confidence disappearing in paper money – this is a genuine question as I could be persuaded to your point of view if I can see its happened before – you mention “many examples” of this in history – could you name any (excluding where the loss of confidence has occurred due to regime change/war/starvation/debts denominated in foreign currency – i.e. important circumstances that differentiate with our current situation)?

    2) You seem to acknowledge that QE/ECB balance sheet increases are required to avoid bankruptcy, by the fact that you assert so in a sentence in your third paragraph. So if you think QE is such a bad thing but is required to avoid bankruptcy, I assume that you must prefer these bankruptcies over QE? You don’t go into details as to why you think that would be the lesser of two evils – I would be interested to hear your opinion on that question. Or maybe you have another way out of this crisis that you have not mentioned? My own preferred way out would be to muddle through until private sector deleveraging has stopped and then start to reduce govt borrowing at that stage.

    Aside from the above, the predicted inflation and currency debasement that Austrian economists, and presumably you, and most of the mainstream press have been warning about over the past 4 years, or so, has just not happened.

    As I alluded to above, it is important in current circumstances to look at the overall indebtedness of both private and public sector to understand the macro picture. No doubt it would be good if there was less debt in total, but when the private sector is reducing its debt massively (certainly occurring per US data) and has been doing so since 2008, then something else has to take up the slack caused by their lowered spending. The only other sector capable of doing so is the public sector. So it follows that, unless we want a massive reduction in GDP, the govt has to borrow more money currently, not less. If you argue otherwise, I think you are arguing against the economic identity Y = C + I + G +X -M

  4. Single Acts of Tyranny says:

    @ Jamie, fair questions.

    As to the first we have revolutionary France with its paper Assignat, at first a success, they printed too much and hey presto hyperinflation. The ever pleasant Argentine government delivered a dose for their hapless populace between the mid 1970′s and the early 1990′s despite a couple of currency replacements which was basically just an exercise in knocking zeros off the paper. The Weimar example is well known. The Mexicans defaulted on their debts because of excess government spending in the early 1980′s capital flight followed (such as the Spanish and Greeks are seeing currently) and in an effort to fix things the government printed with sad results. The collapse of the Berlin wall saw a couple of East European states learn some hard lessons and Mr Mugabe’s recent antics are well documented.

    I would just say that war hardly differentiates us from some historic examples given our involvement in various adventures around the world although I accept the difference in scale you probably mean.

    This will be another case again of course as history always has different shades, but I honestly think the post-war social democratic model is coming to its natural bankruptcy/end. I say this as a neutral observation rather than a comment.

    Your second point is correct in that I would certainly prefer liquidation to QE. Dodgy investments should be corrected by bankruptcy and the assets should be sold off to people who could make a better job of using them. This applies to banks as well as car companies and all the rest. This is what economic corrections do and the America depression of 1920 is a prime example of how the government should act in the face of recession (they halved federal spending in in cash terms between 1920 and 1922).

    As to the emergence of inflation, well given four plus years of recession we should have seen a big correction in asset prices which simply has not been allowed to happen. Instead prices have been moving upwards despite Mervyn telling us every month that they are about to fall and you probably know the hijinks the official stats go through. We may not have seen the serious high inflation figures yet, but I honestly wouldn’t discount them. Banks are hoarding cash to a large degree and this has to go somewhere. When it gets out into the economy, watch out.

    I am afraid I flatly disagree wih your last point. If the private sector deleverages it is for a reason (ie businessmen and individuals on aggregate decide to do so). But the idea that government spending is somehow good and equal to the private sector can’t be right. If businessman A wants to buy plant to produce something or to build a cinema to address a demand he thinks exist, that’s up to him and his funders. If he gets it right he creates wealth and a product or service that is demanded. But if he judges the time is not right then no amount of the local authority employing traffic wardens will create wealth and even the beloved ‘infrastructure projects’ should be avoided. This is because the government has no money so they must loot said businessman and others to fund the boondoggles so people cant spend and invest themselves on what they want. Thus you have something that looks like it creates jobs but the net but unseen effect is to destroy them. Thus Greece and the ‘stimulus’ their olympics delivered or Spain and their empty white elephant airports.

    You are probably right that all the politicians regardless of costume have no stomach for real austerity and will let inflation (that they imagine they can control) erode the debt. This is crypto-taxation in that it empoverishes those with cash in the bank or incomes not linked to inflation.

  5. Paul Marks says:

    The great bust of 2013 is now baked into the cake – it can not be prevented.

    These stupid men have made it inevitable – with their orgy of bailouts and credit money expansion.

  6. Plamus says:

    Jamie:

    In addition to SAoT’s points, you should consider that Y = C + I + G +X -M is not a static equation – it’s difference equation. Classical Keynesians cavalierly assume the equation is Y(t) = C(t) + I(t) + G(t) +X(t) -M(t) – all happening at time t. However, even cursory empirical research find that your other components are not time-independent – au contraire, they are severely and robustly related – for example if you assume balanced budget G(t) = T(ax rate)*Y(t-1) – the gov’t only gets to spend what it has collected in taxes in the previous period. If you alleviate that requirement, you get gov’t debt – but then G(t) affects not only Y(t+1), but also Y(t+2), Y(t+3), etc. And that’s not the only one – I(t) is also a function of C(t-1), for example – businesses invest to meet consumer demand; or even of Y(t-1) – C(t-1), aka savings, which need to be converted into investment; taxes (or negative taxes (subsidies) can be levied on consumption, or investment, or exports, or imports, severely disrupting market signals, etc, etc. The short version of it is – yes, there may be some point in the classical Keynesian idea of the gov’t smoothing cycles. It does not work in reality – google Wassily Leontief – but it’s at least a somewhat coherent intellectual argument. However, it also requires gov’ts to spend less in good times – which (surprise!) never happens, aka the ratchet effect.

    Keynesianism has been hijacked by politicians. It’s attractive aspects (more spending in bad times) are heartily embraced; it’s less attractive aspects (less spending in good times) staunchly ignored – it’s NEVER the right time to scale back – look, the economy is booming, we have all this revenue, if we spend it it’ll be even better, right?

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