But the gains aren’t trickling down to the majority of Americans.
Pope Francis continues to make waves as the new head of the Catholic Church, offering a blistering critique this week of free markets and capitalism in his first apostolic exhortation:
[S]ome people continue to defend trickle-down theories which assume that economic growth, encouraged by a free market, will inevitably succeed in bringing about greater justice and inclusiveness in the world. This opinion, which has never been confirmed by the facts, expresses a crude and naïve trust in the goodness of those wielding economic power and in the sacralized workings of the prevailing economic system. Meanwhile, the excluded are still waiting. [vatican.va]
One year ago, a campaign group affiliated with Occupy Wall Street called Strike Debt announced a campaign called the Rolling Jubilee, which sought to buy up distressed debt for pennies-on-the-dollar — for the purpose of abolishing it.
Historically, a debt jubilee was a feature of ancient Jewish law, under which all debts were written off every seven years. So why is Strike Debt trying to do something similar?
Strike Debt describes the program as a “bailout of the people, by the people.” The group targeted people struggling to service necessary debt, such as those without medical insurance who ended up needing expensive medical care.
So far, the Rolling Jubilee campaign has bought up and written off almost $14 million in debt.
In October, London real estate asking prices jumped 10%. In my view is kind of parabolic-looking jump has developed out of quite a silly situation, and one I think is a good exhibit of just how irrational and weird markets can sometimes be. London real estate prices have been rising strongly for a long while, and a large quantity — over half for houses above £1 million — of the demand for London real estate is coming from overseas buyers most of whom are buying for investment purposes. It is comprehensible that London is a desirable place to live, and that demand for housing in London might be higher than elsewhere in the UK. It is a diverse and rich place culturally and socially, boasting a huge variety of shopping, parks, art galleries, creative communities, restaurants, monuments and landmarks, theatres and venues, financial service providers, lawyers, think tanks, technology startups, universities, scientific institutions, sports clubs and infrastructure. Britain’s legal framework and its straightforward tax structure for wealthy foreign residents has proven highly attractive to the global super rich. With London real estate proving perennially popular, and with the global low-interest rate environment that has made borrowing for speculation cheap and easy, it is highly unsurprising that prices and rents have pushed upward and upward as the global super rich — alongside pension funds and hedge funds — sitting on large piles of cash have sought to achieve higher yields than cash or bonds by speculating in real estate. In some senses, London real estate (and real estate in other globally-desirable cities) has become a new reserve currency. And while this has occurred, price rises have proven increasingly cyclical as both London residents and speculators have sought to buy. The higher prices go, the more London residents become desperate to get their feet on the property ladder in fear they won’t ever be able to do so, and the more speculators are drawn in, seeing London real estate as an asset that just keeps going up and up.
Yet the bigger the bubble, the bigger the bust. And I think what we are seeing in London is a large psychological bubble, a mass delusion built on other delusions. Chief among these delusions is that real estate should be seen as a productive investment, as an implicit pension fund, or as a guaranteed source of real yield. While investors can look at real estate however they like, there is no getting away from the fact that real estate is a deteriorating asset. Sitting on a deteriorating asset and hoping for a real price gain — or even to preserve your purchasing power — is a speculation, not a productive investment. For commercial enterprises buying as a premises for business, or for residents buying as a place to live this is not in itself problematic. But as an investment this can be hugely problematic. It is just gambling on a deteriorating asset under the guise of buying a “safe” asset.
Of course, in the UK where housing has been treated by many successive governments as an investment, and as a haven for savings and pensions, real estate owners have done particularly well. Governments have been willing to prop up the market with liquidity via schemes like Help To Buy and via restrictive planning laws to rig the market to restrict supply. This may make investors feel particularly secure, but governments can be forced — not least by demographics — to swing in another direction. An important side-effect of continually rising prices and a restricted supply of housing is that many people will not be able to afford to buy a home. With the house prices-to-wages ratio sitting far above the long-term average, the next UK government will come under severe pressure within the next few years to allow — and probably subsidise — much more housebuilding to bring down housing costs for the population. The past-trend of government-protected gains may have inspired a false sense of security in investors.
But such a reversal of policy would not in itself crash the London real estate market. After all, London is a unique place in Britain, and the majority of the new housebuilding may take place away from London. More likely, the bubble will simply collapse under the weight of its own growth. Sooner or later, even with liquidity cheap and plentiful, the number of speculators seeking to cash out will exceed the number of speculators seeking to cash in, and confidence will dip. Sometimes, this simply equates to a small correction in the context of a large upward trend, but sometimes — especially when it can be negatively rationalised — it manifests into a deeper malaise.
When this occurs, one probable rationalisation is as follows. Domestically, many of the relatively low-income artists, designers, technologists, musicians, students, artisans, academics, service workers and professionals (etc) who make London London are priced out, then they will go and contribute to communities elsewhere where rents and housing costs are lower — Birmingham, Manchester, Glasgow, Paris, Berlin, out into the sprawl of the home counties, and deeper into the English countryside, to places where a four bedroom house costs the same as a studio apartment in central London. Where once this would have been culturally, professionally and socially prohibitive, fast, ubiquitous internet allows for people to live a culturally and socially connected life without necessarily living in a big city like London. Internationally, other cheaper cities and jurisdictions will simply catch up with London in terms of amenities and desirability to the global super class. Competition for global capital is huge, and while London as an Old World metropolis has done well since 2008, it may suffer in the wake of renewed competition from newer, cheaper, faster-growing Eastern metropolises.
When the bubble begins to burst — something that I think could occur endogenously within the next five years, especially if the fast increases continue — speculators, and especially speculators who are heavily leveraged may face severe problems, resulting in a worsened liquidation and contraction, and possibly threatening the liquidity of heavily-invested lenders. As many people at the table are sitting on big gains, they may prove desperate to cash out. Just as many presently feel pressured to get in to avoid being priced out of London forever, a downward turn could be severely worsened as many who are heavily invested in the bubble and scared of losing gains on which they hoped to fund retirements (etc) feel pressured to get out. Such an accelerated liquidation could easily lead to another recession. While I doubt that London prices will fall below the UK average, prices may see a very sharp correction. The psychological bubble is composed of multiple fallacies — that housing is a safe place to put savings and not a speculation, that deteriorating real estate should yield higher returns than productive business investments, that the UK government will continue to protect real estate speculators, that large flows of capital from overseas speculators will continue into London. A bursting of any of these fallacies could begin to bring the whole thing into question, even in the context of continued provision of liquidity from the Bank of England.
Back in June, I correctly noted that it was severely unlikely that the Federal Reserve would taper its asset buying programs in September. I based this projection on the macroeconomic indicators on which the Federal Reserve bases its decisions — unemployment, and inflation. The Federal Reserve has a mandate from Congress to delivery a monetary policy that results in full employment, and low and stable inflation. With consumer price inflation significantly below the Fed’s self-imposed 2% goal, and with the rate of unemployment relatively high — currently well over 7% — I saw very little chance of the Fed effectively tightening by reducing his asset purchases.
There exists another school of thought that also correctly noted that the Fed would not taper. This other school, however, believes that the Fed cannot ever taper and that the Fed will destroy the dollar before it ceases its monetary activism. This view is summarised by the Misesian economist Pater Tanebrarum:
While it is true that the liquidation of malinvested capital would resume if the monetary heroin doses were to be reduced, the only alternative is to try to engender an ‘eternal boom’ by printing ever more money. This can only lead to an even worse ultimate outcome, in the very worst case a crack-up boom that destroys the entire monetary system.
So the Misesian view appears to be that the Fed won’t stop buying because doing so would result in a mass liquidation, and so the Fed will print all the way to hyperinflation.
Since talk of a taper began, rates certainly spiked as the market began to price in a taper. How far would an actual taper have pushed rates up? Well, it’s hard to say. But given that banks now have massive capital buffers in the form of excess reserves — as well as a guaranteed lender-of-last-resort resource at the Fed — it is hard to believe that an end to quantitative easing now would push us back into the depths of post-Lehman liquidation. Certainly, in the year preceding the announcement of QE Infinity — when unemployment was higher, and bank balance sheets frailer — there was no such fall back into liquidation. What a taper certainly would have amounted to is a relative tightening in monetary policy at a time when inflation is relatively low (sorry Shadowstats) and when unemployment is still relatively and stickily high. Whether or not we believe that monetary policy is effective in bringing down unemployment or igniting inflation, it is very clear that doing such a thing would be completely inconsistent with the Federal Reserve’s mandate and stated goals.
Generally, I find monetary policy as a means to control unemployment as rather Rube Goldberg-ish. Unemployment is much easier reduced through direct spending rather than trusting in the animal spirits of a depressed market to deliver such a thing, especially in the context of widespread deleveraging. But that does not mean that the Fed can never tighten again. While the depression ploughs on, the Fed will continue with or expand its current monetary policy measures. Whether or not these are effective, as Keynes noted, in the long run when the storm is over the ocean is flat. If by some luck — a technology shock, perhaps — there was an ignition of stronger growth, and unemployment began to fall significantly, the Fed would not just be able to tighten, it would have to to quell incipient inflationary pressure. Without luck and while the recovery remains feeble, it is true that it is hard to see the Fed tightening any time soon. Janet Yellen certainly believes that the Fed can do more to fight unemployment. This could certainly mean an increase in monetary activism. If she succeeds and the recovery strengthens and unemployment moves significantly downward, then Yellen will come under pressure to tighten sooner.
In the current depressionary environment, the hyperinflation that the Misesians yearn for and see the Fed pushing toward is incredibly unlikely. The deflationary forces in the economy are stunningly huge. Huge quantities of pseudo-money were created in the shadow banking system before 2008, which are now being extinguished. The Fed would have had to double its monetary stimulus simply to push the money supply up to its long-term trend line. Wage growth throughout the economy is very stagnant, and the flow of cheap consumer goods from the East continues. So Yellen has the scope to expand without fearing inflationary pressure. The main concerns for inflation in my view are entirely non-monetary — geopolitical shocks, and energy shocks. Yet with ongoing deleveraging, any such inflationary shocks may actually prove helpful by decreasing the real burden of the nominal debt. Tightening or tapering in response to such shocks would be quite futile.
Sooner or later, the Fed will feel that the unemployment picture has significantly improved. That could be at 5% or even 6% so long as the job creation rate is strongly growing. At that point — perhaps by 2015 — tapering can begin. Tapering may slow the recovery to some extent not least through expectations. And that may be a good thing, guarding against the outgrowth of bubbles.
Yet if another shock pushes unemployment up much further, then tapering will be off the table for a long time. Although Yellen will surely try, with the Fed already highly extended under such circumstances, the only effective option left for job creation will be fiscal policy.
Back in 2007, I was much more interested in finance and trading than I was in macroeconomics. When the crisis — and the government’s macroeconomic response to the crisis — began in 2008 what was really needed to get a strong grasp of the situation was an understanding of macroeconomics, which I did not have as it was a topic I only really began studying in depth at that time. This led to some misconceptions, particularly about inflation. I mistakenly assumed — as did many at the time, and as do many today — that the huge expansion of the monetary base would lead to stronger inflation than the timid and low inflation we have seen in years since the programs began. While I strongly doubted the claims of individuals like Peter Schiff that hyperinflation might be nigh — as I understood that most historical hyperinflations occurred due to a collapse in production, not solely due to money printing — I thought a strong inflationary snapback was likely, Why? A mixture of real effects and expectations. If central banks are printing money at a higher rate, people will fear that money is becoming less scarce. If having more money in circulation does not begin to bid prices upward, producers will soon begin to raise prices to anticipate any such rise. Simply, I thought that central banks couldn’t print their way out of disaster without some iatrogenic side-effects. I assumed the oncoming pain was unavoidable, and that the onset of inflation was the price that would be paid. As Ludwig von Mises put it: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
So why did that not occur? After all, plenty of internet goldbugs — and very serious people following the advice of people like John Taylor, Eugene Fama, and Niall Ferguson — were talking about the potential for a strong inflationary shock. The gold price was soaring — hitting a peak above $1900 an ounce in September 2011 — as people anticipating inflation sought to buy insurance against it. Well, for a start it seems like the public did not really buy into the notion of an oncoming inflationary shock. Expected inflation as measured by the University of Michigan has remained very close to the post-1980 norm since the crisis:
But above and beyond this, the real monetary effects were not the ones I first assumed them to be. The total money supply — most of which is generated not by the Fed but in the private sector through lending — has been stagnant, even while the Federal Reserve is expanding the monetary base. So while the financial sector is flush with cash and has bid the stock market up above its pre-recession nominal peak, other goods in other sectors just have not had enough of a bid behind them to send inflation strongly upward because other areas of the economy (for instance housing, consumer electronics and real wages) have continued to deflate in the context of continued deleveraging, accelerating offshoring driving down wages and the receding effects of the 2008 oil shock.
Yet even more importantly the supply of goods in the West — flowing as it does from East to West, from the factories of the Orient to the consumers of the West — has remained strong and stable. There has been no destabilising, chaotic Chinese crash or revolution, even though many wished there would be in the wake of the Arab spring. And for all the talk by the Chinese and Russians of bond vigilantism, starting a new global reserve currency and dumping the dollar, that has not happened either. And why would it? Certainly, the Asian bond-buyers might have suffered a few years of negative real interest rates. This might have pissed them off. But undermining the Western recoveries further (which have been quite pathetic thus far) when such a high proportion of their assets — dollars and treasuries and increasingly real assets like land and industrials — are related to the economic performance of the West would be to cut off their nose to spite their face, while simultaneously risking conflict with the American military, whose capabilities remain unmatched. The Chinese and Russian talk of de-Americanisation and a post-American world is all bluff and bluster, all sound and fury signifying very little. In the long run, America will have to accept a world where it is no longer the sole global superpower, but there is no incentive for America’s competitors to hasten that way with the kind of aggressive economic warfare that might cause an economic shock.
On the other hand, it is certainly true that much of the new money entering the system is sitting as excess reserves. Is that a symptom of the inflation simply being delayed? Until the middle of last year I thought so. Now I very strongly doubt it. The existence of excess reserves in the system is not a symptom of stored-up future inflation, but a symptom of the weakness of the transmission mechanism for quantitative easing. Simply, the system is in a depression. The banking system is infected with a deep paranoia, and would prefer to sit on risk-free cash instead of lending money to businesses. If the money was lent out, there would be an increased level of economic and business activity. Therefore there is no guarantee of any additional inflation as the money is loaned out.
So I was wrong to worry that inflation could become an imminent problem. But I was wronger than this. The entire paradigm that I was basing these fears upon was flawed. Simply, I was ignoring real and present economic problems to worry about something that could theoretically become a problem in the future. Specifically, I was ignoring the real and present problem of involuntary unemployment to worry about non-existent inflation and non-existent Asian bond vigilantes. The involuntariness of unemployment is a very simple fact — there are not enough jobs for the number of jobseekers that exist, and there hasn’t been enough jobs since the crisis began. Currently there are just over three job seekers for every job. So unemployment and underemployment are not simply things that can be dismissed as a matter of workers becoming lazy, or preferring leisure to work. Mass unemployment has insidious and damaging social effects for individuals and communities — people who are out of work for a long time lose skills. For communities, crime rises, and health problems emerge. And there are 25 million Americans today who are either unemployed or underemployed as a practical matter it is not simply a case of sitting back and allowing the structure of production to adjust to the new economy. And worse, with unemployment high, spending and confidence remain depressed as the effects of high unemployment create a social malaise. This is a mass sickness — and in the past it has led to the rise of warmongering political figures like Hitler. So while it may be preferable for the private sector to be the leading job creator under ordinary conditions, while the private sector is engaging in heavy deleveraging this is impractical. Under such an eventuality the state is the only institution that can break the depressionary trend by creating paying jobs and fighting back against the depressionary tendency toward mass unemployment. Certainly, centralised bureaucracy is a troublesome thing. But there are many things — like mass unemployment and underemployment, and the social order that that can bring — worse than centralised bureaucracy. And no — this kind of Keynesianism was not the problem in the 1970s.
By worrying over the potential for future inflation or future bond vigilantism due to monetary and fiscal stimulus, I was contributing to the problem of mass unemployment, first of all by not acknowledging the problem, and second by encouraging governments and individuals to worry about potential future problems instead of real-world problems today. As it happened, a tidal wave of evidence has washed these worries away. It is clear from the economic data that inflation is not a concern in a depressionary economy, just as Keynesian-Hicksians heuristics like IS/LM suggested.
Of course, if the depression ends then inflation could become a problem again. If the United States were to experience a strong unexpected spurt of growth sustained over a year or so, pushing unemployment down below 3%, growth above 3%, inflation could rise appreciably. The Federal Reserve would have to quickly taper both its unconventional policies and probably begin to raise rates. Of course, that is rather unlikely in the present depressionary environment. But certainly, it is a small possibility. That would be the time for the Federal Reserve to start to worry about inflation. A strong negative energy shock — like the one experienced by the UK in 2010 and 2011 — could push inflation higher too, yet that would be a transitory factor in the context of the wider depressionary environment, and would most likely fall back of its own accord.
If the Fed was engaging in actual helicopter drops — the most direct transmission mechanism possible — there would likely be a stronger inflationary response than that which we have seen thus far. Yet ultimately, this might prove desirable. After all, if the private sectors of the entire Western world have a very large nominal debt load which they are struggling to deleverage, some stronger inflation would certainly begin to minimise that. Yes, that is redistribution from lender to borrower. No, creditors will not be happy about this. But in the end, creditors may find it easier to take an inflationary haircut than face twenty years of depressionary deleveraging as Japan has done. Although the West certainly does not have the same demographic troubles as Japan, such an outcome is possible unless people — governments, entrepreneurs, individuals, society — decide that unemployment and a lack of demand in the economy must be tackled, and do something about it. Then can we confidently expect to climb out of the lip of the deleveraging trap.
In this post, I am not going to argue that the USA should not default because it will cause havoc in global financial markets. This — if the debt limit is not raised or abolished via a trillion dollar coin or other means by October the 17th — is a distinct possibility, but much has been said of this already. Nor am I going to argue that the United States Treasury will somehow manage to skirt defaulting via emergency austerity measures. This is possible too, though has also been discussed elsewhere.
I am going to argue that in the long run, whether the United States raises the debt ceiling or not, it is technically impossible for the United States to default. This simple fact is encoded in the Fourteenth Amendment to the Constitution:
Section 4. The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.
While bondholders may not get their money including interest immediately, the courts will rule in their favour when the matter comes to court. The Fourteenth Amendment is absolutely clear on that. Some credit default swaps may trigger (this depends, I think, on the wording of individual credit default swap contracts, which in itself may cause further confusion) but in the end bondholders will absolutely and assuredly get their money. This means that United States Treasuries remain low-risk assets. And that — even in the event of default — should keep interest rates on Treasury debt relatively low. There will be no crushing exit of the bond vigilantes — after all, why would they choose to crash a market they are already deeply invested in if they will sooner-or-later get paid? People, generally, who buy large quantities of US Treasuries are not sitting around and reading libertarian blogs pondering the issues of dollar debasement and the end of the dollar as the global reserve currency. The latter may be a real longer term issue, and I think in the next 50 years, perhaps even the next 20 years we will see more alternative reserve currencies emerge. But that is another story for another day.
In the medium term and the short term the thing that is keeping bond buyers buying bonds is the search for yield over cash. If you have billions of dollars in cash at your disposal as many investment managers and countries do, and your imperative is low-risk yield, government debt beats cash that yields nothing, it beats commodities speculation and stock market speculation, and it beats corporate bonds as corporations are not sovereigns. A guaranteed dollar-denominated yield, even a very low one is still very attractive to treasury buyers, even if some large treasury buyers like the Chinese government have made some bond-vigilante-like noises in the past few years. These have thus far proven to be hot air, even if I have in the past made the mistake of paying too much attention to such noises.
Personally, I wish to see the debt ceiling abolished entirely, either through the absurdity of trillion dollar coins (my original objection, that authorising a trillion dollar coin would look silly has been made entirely moot by the fact that the United States Congress already looks extremely silly due to the ongoing standoff) or otherwise. At the very least, the debt ceiling should be denominated in real economic activity, not an arbitrary number of dollars, and in setting such a ceiling it should be remembered that Great Britain successfully sustained and paid down a sovereign debt of over 250%. Higher sovereign debt levels for a rich, powerful country like the United States are not dangerous. It is — as we are seeing — destructive both to markets and to society that a sovereign can be reduced to gridlock and turmoil and confusion over such a simple thing as a spending or borrowing authorisation. The real dangers here are not overspending or running out money, but unnecessary forcible austerity imposed by lawmakers, sucking money and economic activity out of the economy, and creating chaos and confusion in markets. There are already many real problems in the US economy — millions of people unemployed, weak growth, lack of job creation, private debt overhang and slow, painful deleveraging. The last thing the US economy needs is an unnecessary crisis of uncertainty and confusion created by economic illiterates in Congress.
I came into economics and finance blogging in 2011 a very different economic thinker than I am today. I was convinced (and remain convinced) that we were going through a once-in a generation economic transformation, or more accurately an industrial revolution the shape of which remained uncertain. These ongoing industrial revolutions, of course, cause great upheavals. As Joseph Stiglitz has noted, the Great Depression of the 1930s can be seen as a great displacement of labour in agriculture thanks to technological improvement. Stiglitz, like myself, sees a parallel between today’s slump and that of the 1930s; in the 1930s we were transitioning out of agriculture. We are also in a transitional period today. Since the advent of globalisation, and the growth in automation in the 1970s and 1980s society had begun suffering from falling real wages, and had had to lever up on debt in order to sustain lifestyles and spending habits. The financial sector had taken advantage of this, offering cheapish debt and — morally hazardously — securitising these debts and selling it a greater fool. This was a bomb waiting to explode — because lenders did not have to take responsibility for the fruits of their lending, they could lend to any NINJA, pay the credit rating agencies to grade highly speculative debt as AAA-grade, and sell it to another bank, or a pension fund, or a hedge fund. When the financial crisis blew up, I desired very, very strongly to see the entire corrupt market liquidated. This was an entirely Darwinian wish; financial firms had acted irresponsibly, creating a monstrous system that nobody really understood and they should pay the consequences for their irresponsibility. In liquidation, people would learn a harsh lesson and the economy would be forced to adapt to the new reality. In Hayekian terms, I thought that the structure of production ought to be left alone to adjust.
So I was furious to see the financial sector bailed out and rescued, and I strongly suspected that such medicine would have very harsh negative side effects as the speculators had been rescued instead of learning their lesson the hard way. Maybe the bankers and financiers who got bailed out — and the regulators who were found to be asleep at the wheel — have not learned a lesson. We shall see. Yet, when push came to shove, governments and central banks chose to save the system instead of watching it burn to the ground and given the complexity of the system, and the danger of good businesses being destroyed alongside the speculators and shysters, that is an entirely understandable decision. Certainly, it was also a morally questionable decision — after all, while bankers and financiers get bailed out in an emergency, help for the much poorer fringes of society is much less forthcoming. Yet this is the world in which we live in.
Of course, the world goes on. Banks may not have been disciplined, but the structure of production still must adjust to the new world, albeit in a less brutal and immediate fashion. This has been far from simple. Even though the financial system was saved, economies around the world remained in a depression. In fact, I would define an economic depression in these terms — a depression as opposed to a transitory recession, which relatively quickly self-corrects is a situation in which the structure of production cannot adjust itself back into a pattern of growth, and economic activity becomes permanently lowered. In Britain and the Eurozone we are so far behind our pre-crisis trend that we still as of October 2013 have not grown our way out of the trough yet, let alone caught up with the long term trend line:
The causes of this are multiple and complex. We are in an the midst of an ongoing industrial revolution, a great whirling flourish of creative destruction in which both foreign labour and automation are displacing both manufacturing and increasingly service industries. This creates real ongoing instability. Furthermore there remains the fallout from the crisis — confidence in new job-creating and growth-creating business ventures may have become inherently depressed, as economic expectations drift lower and lower in the context of low growth. Then there is the ongoing trend of government austerity, taking money and jobs out of the economy. Energy prices remain relatively high by historical standards, as we rely on old and increasingly expensive oil-based infrastructure (although I expect energy costs to begin to fall as we transition to newer energy architectures). The private sectors in most Western countries remain in deleveraging mode from a very large private debt overhang from before the crisis, limiting their consumption and investment and paying down debt. These are just some of the possible causes of depressed growth and elevated unemployment that we see.
Governments particularly in Britain and the Eurozone have attempted to fight depressed growth using austerity policies (in the context of expansionary monetary policy). The proponents of austerity theorise that by promising to bring down taxes and spending, they will unleash private sector spending by reducing future expectations of taxes. To me, this has always seemed like a boneheaded and Rube Goldberg-style approach. Simply, the issue of depressed private economic activity is far more complex than future taxation expectations. And aggressive monetary policy has not succeeded in reversing the depression(even if it has probably made the depression less severe). So it has been entirely unsurprising to me to see this approach largely failing. I approach the problem in a far more direct manner. The solution to lowered growth and elevated (and involuntary) unemployment is relatively simple. Eventually someone will start using up the idle resources. This will either be the private sector once it independently gets over its slump in animal spirits, or it will be the government. With such huge volumes of idle capital, interest rates will remain very low until stronger appetite for credit re-emerges. In equilibrium theory, the low cost of credit will by itself start to re-energise borrowing appetite by making more projects potentially profitable. Of course, interest rates are far from the only factor that borrowers take into account when seeking credit, and so it is perfectly plausible that the economy — as it has done — can remain depressed even with very low rates due to deleveraging pressures, low expectations and low confidence, etc. So if the market is ill-suited to taking up the idle resources any time soon — lying as it is in a depressive, irrational strop — the only agent that can do so is the state. The fact of low interest rates allows this to kill two birds with one stone — the state can borrow money (utilising idle capital) to create jobs (utilising idle labour), raising interest rates and bringing down the unemployment rate. And this approach does not require anyone to make accurate predictions about the future. It simply requires a market economy, and a state willing to employ idle resources when they are idle, and to ease off using idle resources when unemployment becomes low and interest rates start to rise.
Many — including probably Hayek himself — would argue that using up idle resources in such a manner will not allow the structure of production to adjust to the new economic reality. The state, Hayek would argue is a poor allocator of capital because it lacks the informational efficiency of the market. I would mostly agree with Hayek’s objection, and note that I favour a predominantly market-based economy. Government interventions should be kept to a necessary minimum. Yet, in a depressionary environment, the structure of production deteriorates as resources lie idle. Unemployed workers lose skills, lose competitive edge and spend and invest less, further depressing the economy. Capital — factories, buildings, amenities, ideas, etc — deteriorates. Young workers may enter the labour force but never find a job. Crime rises, and shady fringe businesses like loan sharks thrive as the unemployed struggle to pay the bills. The social costs of mass unemployment are exceedingly high. The adjustment occurring in a depression is more like a rot. And it is absurd to rot your way to growth. Instead, by lowering unemployment and using up idle capital (preferably in a mix of state-run infrastructure and technology projects, and lending to new businesses) more businesses can be born into existence. Potentially successful new ideas can be tried out, and may find success in the marketplace. The formerly unemployed get to develop skills, habits and ideas, instead of sitting at home all day doing nothing, or hunting for jobs in a scarce and depressed marketplace. And money will go into people’s pockets, spurring investment and consumption, fomenting more new business growth. This, in my view, is the best shot at getting a depressed and rotten structure of production out of the doldrums and back toward strong organic growth. Sooner or later, of course, the private sector will come back and begin to use up resources. But that could be a very, very, very long way away. If we want the structure of production to adjust to the new world and to continue adjusting as the world continues to change, letting huge quantities of resources sitting idle seems like a bad way to do it. Targeted fiscal policy can change that.
George Osborne just came out in favour of counter-cyclical policy — saving more in the boom, and spending more during a “rainy day”. This is consistent with John Maynard Keynes’ notion that “the time for austerity at the Treasury is the boom, not the slump”.
The thing is, George Osborne seems to believe that right now we are moving toward a boom and need to adopt the policies of the boom:
Chancellor George Osborne has said he wants the government to be running a surplus in the next Parliament and can get there without raising taxes.
He told the Conservative conference the public finances should be in the black when the economy was strong as insurance against a “rainy day”.
His comments were taken as suggesting more years of spending restraint.
Business welcomed the goal but Labour said Mr Osborne had missed targets before and could not be trusted.
The BBC News Channel’s chief political correspondent Norman Smith said Mr Osborne’s underlying message was that austerity would continue after the next election despite the return to growth.
If 7.8% unemployment and a smaller real economy than 5 years ago doesn’t constitute a rainy day, I’d like to know what does. To me, and to many economists this kind of thing doesn’t just constitute a rainy day, it constitutes a full blown great depression. Eventually, sooner or later, someday the economy will return to growth and full employment. With the right luck — technology breakthroughs and other exogenous shocks etc — that could be two or five years from now. The experience of Japan, however, who have endured a 20 year depression suggests that it could be much later rather than sooner.
The safer alternative is to use fiscal policy — as Osborne himself implies — during the rainy day to directly bring back full employment sooner, rather than later by engaging in infrastructure projects and the like. Even if a government hasn’t saved money during the boom, interest rates are so low during the slump that it is cheap to do so, even in the context of soaring national debt levels as is the case in Japan today.
Getting the economy to a point where the government can run a budget surplus, of course, is still a noble ambition. But Osborne has shown no awareness whatever of the steps that need to be taken to get to that position. Infrastructure and housing investment and a jobs program would be a start. So too would liberalising planning laws and lending to and deregulating business startups so that more houses can get built and more businesses can get started. For now, Osborne is preaching responsibility while doing something deeply irresponsible — prolonging a depression with unnecessary demand-sucking job-killing austerity. The boom, not the slump, is the time for austerity at the Treasury and this (for the love of God) is not the boom.
Once upon a time there was a strong correlation. Then it broke:
Of course, we know that correlation is not and does not imply causation. But I think there was an underlying causation to the relationship that we saw, but it was not a superficial relationship of more asset purchases, higher gold prices. I think the causation arose out of self-confirmation; people noticed that the Fed was printing money, and believed that expansion of the Fed’s balance sheet would lead to price inflation (in ignorance of the fact that the broadest measure of the money supply was still shrinking in spite of all the new money the Fed was injecting into the economy, and the fact that elevated unemployment, weak demand, and plentiful cheap goods make it very hard for strong inflation to emerge). Many others believed that in the wake of 2008 and the shadow banking collapse, the financial system was fundamentally broken, and that the world might have to return to the gold standard. I myself believed that at the very least the West was in a prolonged Japanese style deflationary depression that in the absence of a return to strong growth might only be broken by very high inflation or a liquidationary crash.
Neither of these predictions — of imminent elevated inflation (or hyperinflation), and of imminent catastrophic financial system breakdown — have come to pass. Core inflation is close to its lowest year-on-year rate in history, and further financial system failures have mostly been prevented. So expectations have been shaken and are adjusting. Gold doesn’t produce any yield other than speculative price gains, but when gold is going up in price by around 20% a year it is still an attractive thing to hold to many, especially in an environment where its year-on-year speculative yield vastly outstrips bond yields and rates on savings. Once gold stopped going up by such a margin, investors had to sell their gold to lock in any speculative gain they might be holding onto, resulting in selling. And once gold started to fall, investors faced negative yields on gold, further spurring selling. This has meant gold has faced strong headwinds, and that is why its price has dropped by over 30% since its all-time high in September 2011, even while the Federal Reserve balance sheet continued to soar. Correlation broken. And in a market where the only yields are speculative gains, lost momentum can spell long-term depression as we saw for almost 20 years between 1980 and 2000.
Where gold goes from here is an interesting question. The main spur that pushes gold as an asset is goldbug ideology — the notions that it is the only real money, that it has intrinsic value, that fiat financial systems — and even modern civilisation in general — are fundamentally unmanageable and unsustainable and prone to collapse. As the technologies of capitalism, energy and production improve and advance, these goldbug views have been allayed and pushed to the margins as occurred in the 1980s and 1990s. In my view, their resurgence in the early 21st century stems almost entirely from the fact that real energy prices were rising, and real incomes falling. These two phenomena and their causes are complex and interconnective but essentially the energy infrastructure that brought the world spectacular growth and pushed all boats higher on a rising tide from the early 20th century to the 1990s began to come under strain — cutting into firms’ incomes, and individuals’ living expenses — and it has taken a long while for the market to even begin to equilibriate away from the increasingly-expensive old energy infrastructure and toward new infrastructures (initially increased U.S. production of shale, but going forward renewables especially solar). And while through financialisation and utilising insider-advantage much of the economic and financial elite managed to keep growing their incomes strongly, the vast majority came under stronger financial pressures and were only capable of sustaining their standard of living through debt-acquisition, which itself became a strain due to debt service costs.
As energy prices begin to fall (in what future economists may call a series of technology shocks), as private deleveraging proceeds strongly (with or without higher inflation) and as new cost-cutting technologies such as 3-D printing become more widespread real incomes will probably begin to rise again for the masses indicating a new supercycle of growth and pushing goldbug and other scarcity-concerned views to the fringes once more. We are, I think, moving inexorably to a world of superabundance, whether we like it or not. (Of course, in such a world assets like gold may still have a popular following to some degree, but that is another story for another day).
So even while the Federal Reserve continues to expand its balance sheet into the future in an effort to keep the US financial system liquid and further lubricate private deleveraging (and simultaneously chasing the elusive unemployment-reducing properties of Okun’s Law), the broken gold-Fed correlation is likely to break down even more.