How saving endangers the economy — and what to do about it

An impressive video featuring former Treasury Secretary Larry Summers has been making the rounds.

Summers makes the case that the United States and other Western nations may have reached a state of permanent stagnation in growth and employment. In Japan, per capita incomes grew strongly until the 1990s, and since then they have been growing very weakly and intermittently. Summers cites Japan as an early example of what might occur elsewhere.

Japan’s stagnation is shocking — today, the Japanese economy is only half the size economists in the 1990s predicted it would be if it had continued on its pre-1990s growth trend. As Summers notes, in the U.S., growth is also well below its pre-crisis trend, and unemployment remains persistently high. More than 12 million people who want work and are actively looking cannot find it. That’s a very ugly situation.

Under normal conditions, central banks can lower interest rates on lending to banks as a way to encourage activity and fight unemployment. Lower rates make business projects easier to afford, and more business projects should mean more jobs. If an economic shock pushes the unemployment rate up, central banks can lower lending rates to ease conditions. And conversely, if economic conditions are overheating and inflation is pushing up above the Federal Reserve’s target of 2 percent, interest rates can be hiked to encourage saving and discourage spending.

Yet in the current slump, unemployment has remained elevated even while interest rates have been at close to zero for four years while inflation has remained contained. This suggests that the interest rate level required to bring employment down significantly is actually below zero. Summers agrees:

Suppose that the short-term real interest rate that was consistent with full employment had fallen to negative 2 percent or negative 3 percent sometime in the middle of the last decade.

But central banks can’t lower interest rates below zero percent because people can just hold cash instead. Why invest if you’re going to lose money doing so?


The London Real Estate Bubble


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.

On Depressions, the Structure of Production & Fiscal Policy

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.

On the Possibility of Hyperdeflation


Even given the failure of hyperinflation to pass since a variety of pop-Austrian TV finance pundits predicted it since 2008 in the wake of the various quantitative easing programs, the world at large continues to talk of the possibility of hyperinflation in the future. The value and purchasing power of money is a significant topic for the entirety of society — savers, debtors, large and small businesses, workers, welfare recipients, pensioners, etc — so it is no surprise that people fixate upon historical events in which the purchasing power of money has gone to zero. Yet this previously-known and widely talked about phenomenon may not occur in the future for most countries. Instead, a previously unknown phenomenon that I now tentatively coin hyperdeflation may be far more common.

Hyperinflation is an interesting phenomenon. As I have noted in the past, it seems to be predominantly associated with collapses in agriculture, infrastructure and transport, the loss of a war or natural disasters. Faced with dire economic breakdown and spiralling prices and wages (as plentiful paper money chases after increasingly scarce and limited goods) monetary policymakers are forced to print in an attempt to keep a broken economy going. In a functional economy like present day Japan, Britain or America with no mass breakdown of institutions, transport or infrastructure (and thus with with freely available food, energy and resources) printing (or digitally multiplying) money does not lead to huge, soaring inflation. But in an economy already disrupted — like the many countries on this list that experienced hyperinflation — the inflationary impact of new base money just continues to spiral, and all the extra paper dumped into the system is simply abandoned and rejected by the public as its purchasing power gravitates toward zero.

And in the modern world, some countries and places may have become more susceptible to the kinds of economic breakdowns that could lead to hyperinflation given a bad-enough shock. In an increasingly interconnective and trade-dependent world, natural disasters or wars can shut off the supply of important products or components that countries or regions do not and cannot manufacture. That makes this a particularly fragile phase of history, even if it does not seem so given the huge and widespread affluence not just in the West, but also increasingly in the developing world.

Yet beyond this phase of history, stretching out into the long run, the opposite may become true. Society is shaped by its technological capacities — this has been true since the days of the spear, the wheel, the bow, etc — and our technological evolution continues at ever rapider rates. The internet has already provided a channel for mass cultural interconnectivity, and the effective decentralisation of media. I have written at length on the possibility of superabundant decentralised energy from falling solar and alternative energy costs, combined with the possibility of mass decentralised molecular manufacturing. Simply, if every house has an advanced 3-D printer that can transform soil and waste into food, consumer electronics, or tools (etc), and a superabundant energy source from high-efficiency solar panels (or artificial fossil fuels, or even micro-nuclear reactors) then the era of material scarcity is effectively over, and humanity can concentrate its energies on other matters (cultural, religious, philosophical, space colonisation, etc). Now, we are still a while away from a single house having such capacities, but the implications of the beginning of that era will be profound.

My supposition is that the era of superabundance will be characterised by very strong deflation as the supply of goods and energy becomes increasingly superabundant. This trend has already begun in the West, where inflation and interest rates have — in the context of cheap Eastern labour, computerisation and automation — been falling for the last 20 years. Even strong quantitative easing by central banks has not reignited strong inflation. My guess is that unless we experience some huge shock that dramatically shakes the foundations of society — like a megatsunami, or a nuclear war, or a mass pandemic that wipes out half the population — it will be hard for strong inflation to ever return no matter how much money central banks print. Central bankers may be able to keep inflation close to zero with strong activist monetary policy, but even that may be challenging especially as the age of superabundance draws onward.

Of course, in a world of material superabundance, trade and business will not end. While everyone may have a molecular factory in their house that can build anything from a huge library of open-sourced 3-D designs downloadable from the internet, people will still have to design things and create things. Although at some stage the machines may become sentient and creative, this appears to be at least a very, very long way away. So all the 3-D printers, robots and unlimited energy in the world won’t for the foreseeable future invent things, or write a Hamlet or a Breaking Bad, or a Dark Side of the Moon or an Emperor Concerto, leaving humans an important niche as designers, empathisers and imagineers. While with superabundant energy and goods, people will have all the resources necessary to devote themselves to such pursuits, people as they have done throughout history will still choose to co-ordinate and collaborate, so they will still need some currency. Whether this will take the form of state fiat money, or private currencies like Bitcoins, Facebook and Youtube likes, or Whuffies, or a mixture of the above remains to be seen.

Another possibility, of course, is that there will still be scarcities even in the era of superabundance. While every house may be able to manufacture an unlimited quantity of food, household goods and gadgets, some highly-desired technologies and goods like interstellar spacecraft or particle accelerators or exotic matter may remain far beyond the reach of a typical household or community either on technological grounds or on the grounds that they are contraband (it is quite easy to imagine that manufacturing of certain goods — weaponry in particular — may be made illegal by states, who may create increasingly sophisticated and Orwellian surveillance structures to prevent the distribution of illegal materials). These post-superabundance scarcities may form the basis of new widespread media of exchange and units of account, especially if state fiat money hyperdeflates its way to irrelevance.

(And yes — in an age of superabundant energy, gold will in all likelihood lose its scarcity, as with enough energy it is possible to transmute lead into gold in a particle accelerator. This means it is quite possible that gold’s all-time high of $1917 in September 2011 may be the highest dollar-denominated price gold ever trades at).

Why Savers Should Put Up Or Shut Up

There is an idea popular in certain circles that low interest rate policies are stealing from savers. When the economy went into freefall in 2008, central bank interest rates were lowered to the zero bound. And rates for savers and investors in both government and corporate debt have certainly fallen since then:


Critics of low interest rate policies actually have the wrong end of the stick. It is not central banks that set interest rates for the market. Central banks set lending rates into the banking system. The interest rates in the market remain a function of the demand for savings. Demand for savings (shown as a percentage of GDP, to show the real level of demand for savings relative to economic activity) has absolutely soared since 2008:

fredgraph (22)

How can savers expect a positive real return on their savings when the demand for savings has gone so high even in the context of lower interest rates in general? Central bank policy is designed to discourage saving and encourage investment and consumption. That’s the point — but even with interest rates close to zero, the growth in savings has not been stanched. All else being equal, had central banks not cut rates, demand for savings would be even higher. And with higher demand for savings, that would have just depressed interest rates to the levels we see now irrespective of central bank policy.

The great irony here, of course, is that there are still high rates of return for those with capital if they look for it. Payday loans companies continue to charge companies interest rates in the thousands of percent lending to people with poor credit histories or who may have lost their jobs in the context of the bad economy. Access to capital is not universal or even widespread. Real incomes are flat on where they were five years ago, which has led many individuals and families into borrowing to meet their bills. The fact that the financial industry is lending to some at huge interest rates and denying credit to many businesses while simultaneously paying smaller interest rates to savers is not symptomatic of theft from savers — it’s symptomatic of financial industry dysfunction, and a failed transmission mechanism.

For savers, positive real return on capital is not a right, and it should not be an expectation especially in a depressed economy. If businesses aren’t mostly expanding and taking on new workers, where is the positive real return going to come from? If wages aren’t rising, where is the positive real return going to come from? If the economy isn’t growing where is the positive real return going to come from? The answer is that with a pie that isn’t growing, those who get a bigger slice will be dispossessing others. Simply, high real rates of interest in the context of a depressed economy are rents, and demanding them — and especially demanding that the government enforce their existence — is rent seeking. This is ultimately why a low-growth environment is naturally and in the long run unavoidably a low interest rate environment. It is not central bank theft. It is the inevitable outcome of a depressed economy.

Savers looking for a larger rate of return should know damn well what to do — take their money out of low interest savings accounts and out of the failed financial intermediation industry and invest it into quality economic projects that create jobs and growth. This could involve buying the stock or debt of large companies that wish to expand, or it could involve starting your own business, or investing in a startup or a mixture of these things. The easiest way to return to growth — and thus higher interest rates, and higher returns for things like pension funds — is for today’s savers complaining about low interest rates to turn into tomorrow’s investors seeking out and pouring money into quality projects that increase incomes, create jobs and create products that people desire and want to use. Sitting on cash in a bank account in the dysfunctional financial system and whining about a low return is incoherent nonsense.

Minsky, the Lucas Critique, & the Great Moderation

Last week, I noted that the post-2008 world had provided an astonishingly good test for Milton Friedman’s notion that stabilising M2 growth was an effective antidote for economic depressions. Bernanke stabilised M2 growth, yet the depressive effects such as elevated unemployment, elevated long-term unemployment, and depressed growth still appeared, although not to such a great extent as was experienced in the 1930s. Friedman-style macro-stabilisation may have succeeded in reducing the damage, but in terms of preventing the onset of a depression Friedman’s ideas failed.

Of course, the onset of the post-2008 era was in many ways also a failure of the previous regime, and its so-called Great Moderation. Ben Bernanke in 2004 famously noted that “one of the most striking features of the economic landscape over the past twenty years or so has been a substantial decline in macroeconomic volatility”.  Bernanke saw successful monetary policy as a significant reason for this stabilisation:

The historical pattern of changes in the volatilities of output growth and inflation gives some credence to the idea that better monetary policy may have been a major contributor to increased economic stability. As Blanchard and Simon (2001) show, output volatility and inflation volatility have had a strong tendency to move together, both in the United States and other industrial countries. In particular, output volatility in the United States, at a high level in the immediate postwar era, declined significantly between 1955 and 1970, a period in which inflation volatility was low. Both output volatility and inflation volatility rose significantly in the 1970s and early 1980s and, as I have noted, both fell sharply after about 1984. Economists generally agree that the 1970s, the period of highest volatility in both output and inflation, was also a period in which monetary policy performed quite poorly, relative to both earlier and later periods (Romer and Romer, 2002). Few disagree that monetary policy has played a large part in stabilizing inflation, and so the fact that output volatility has declined in parallel with inflation volatility, both in the United States and abroad, suggests that monetary policy may have helped moderate the variability of output as well.

Bernanke’s presumptive successor, Janet Yellen explained in 2009 that from a Minskian perspective, this drop in visible volatility was itself symptomatic of underlying troubles beneath the surface:

One of the critical features of Minsky’s world view is that borrowers, lenders, and regulators are lulled into complacency as asset prices rise.It was not so long ago — though it seems like a lifetime — that many of us were trying to figure out why investors were demanding so little compensation for risk. For example, long-term interest rates were well below what appeared consistent with the expected future path of short-term rates. This phenomenon, which ended abruptly in mid-2007, was famously characterized by then-Chairman Greenspan as a “conundrum.” Credit spreads too were razor thin. But for Minsky, this behavior of interest rates and loan pricing might not have been so puzzling. He might have pointed out that such a sense of safety on the part of investors is characteristic of financial booms. The incaution that reigned by the middle of this decade had been fed by roughly twenty years of the so-called “great moderation,” when most industrialized economies experienced steady growth and low and stable inflation.

Minsky’s financial instability hypothesis can be thought of as an instance of the Lucas Critique applied to macro-stabilisation. Lucas’ contribution — earlier stated by Keynes — is that agents alter their behaviour and expectations in response to policy.  By enacting stabilisation policies, policy makers change the expectations and behaviour of economic agents. In the Minskian world, the promise and application of macro-stabilisation policies can lead to economic agents engaging in increasingly risky behaviour. A moderation is calm on the surface — strong growth, low inflation — but turbulent in the ocean deep where economic agents believing the hype of the moderation take risks they would otherwise not. In a Minskian world, these two things are not separate facts but deeply and intimately interconnected. Whichever way monetary policy swings, there will still be a business cycle. Only fiscal policy — direct spending on job creation that is not dependent on market mood swings — can bring down unemployment in such a context while the market recovers its lost panache.

The march of monetarists — following the lead of Scott Sumner — toward nominal GDP targeting, under which the central bank would target a level of nominal GDP, is a symptom of Friedman’s and the Great Moderation’s failure. If stabilising M2 growth had worked, nobody would be calling for stabilising other monetary aggregates like M4 growth, or stabilising the nominal level of economic activity in the economy. Sumner believes by definition, I think, that the policies enacted by Bernanke following 2008 were “too tight”, and that much more was needed.

Of course, what the NGDP targeters seem to believe is that they can have their Great Moderation after all if only they are targeting the right variable. This view is shared by other groups, with varying clinical pathways. Followers of von Mises’ business cycle theory believe that an uninhibited market will not exhibit a business cycle, as they believe that the business cycle is a product of government artificially suppressing interest rates. Minsky’s financial instability hypothesis and its notion that stability is destabilising is a slap in the face to all such moderation hypotheses. The more successful the moderation, the more economic agents will gradually change their behaviour to engage in increasingly risky activities, and the more bubbles will form, eventually destabilising the system once again. Markets are inherently tempestuous.

Or at least that is the theory. It would be nice to see empirical confirmation that the moderation produced by Sumnerian NGDP targeting is just as fragile and breakable as the Great Moderation. Which, of course, requires some monetary regimes somewhere to practice NGDP targeting.

Why Does Anyone Think the Fed Will Taper?

Simon Kennedy of Bloomberg claims:

The world economy should brace itself for a slowing of stimulus by the Federal Reserve if history is any guide.

Personally, I think this is nutty stuff. In enacting QE3, Bernanke made pretty explicit he was targeting the unemployment rate; the “full-employment” side of the Fed’s dual mandate. And how’s that doing?

fredgraph (21)

It looks like its coming down — although, we are still a very long way from full employment. And a lot of that decrease, as the civilian employment-population ratio insinuates, is due to discouraged workers dropping out of the labour force:

EMRATIO_Max_630_378 (1)

Moreover, of course, quantitative easing — substituting zero-yielding cash into the money supply for low-yielding assets — is about the Federal Reserve attempting to reinflate the shrunken money supply resulting from the collapse of shadow intermediation in 2008. And the broad money supply remains extremely shrunken, even after all the QE:

And the bigger story is that America is still stuck in a huge private deleveraging phase, burdened with a humungous debt load:

Japan, of course, tapered its stimuli multiple times at the faintest whiff of recovery. Bernanke and Yellen will be aware of this.

Much more likely than abandoning stimulus is the conclusion by the next Fed chair — probably Yellen — that the current transmission mechanisms are ineffective, and the adoption of more direct monetary policy, including helicopter money.

Of Joseph & Keynes

Although Keynes’ conceptual framework for macroeconomics was original, the economic ideas broadly known as Keynesianism — the possibility of unclearing markets, and countercyclical spending — are much older than John Maynard Keynes, and their continued predominating association with him is rather puzzling to me. Indeed, looking at Keynes’ ideas through the lens of his predecessors is illuminating.

According to Genesis in the Old Testament, in ancient Egypt, Joseph son of Jacob warned the Pharaoh that his dreams foretold seven years of abundant harvest to be followed by seven years of poor harvests. Farming in the Nile delta depended on good rainfall in the highlands of central Africa to flood the delta area with water and fertile topsoil. Without good rainfall, Egypt was susceptible to famine.

Joseph told the Pharaoh to store a surplus of grain during the first seven years so that the country would have grain during the drought. During the time of plenty, Joseph ordered the storage of 20 percent of farmers’ output in the Pharaoh’s granaries.

This was a countercyclical fiscal policy millennia before Keynes. If we are to be historically correct, Keynesianism might be better known as Josephianism. And although Joseph’s coat-of-many-colours might arouse the suspicions of certain homophobic critics of Keynes, it is noted that Joseph’s wife bore him two sons.


Keynes’ notion of disequilibrium was a reaction against an idea that only grew wings roughly 130 before Keynes with the industrial revolution — Say’s Law, the notion that “products are paid for with products”, that “a glut can take place only when there are too many means of production applied to one kind of product and not enough to another” and that subsequently “a rational businessman will never hoard money; he will promptly spend any money he gets “for the value of money is also perishable.”

Say’s Law is empirically false. Under certain conditions — including the present condition —  savings levels can soar uncontrollably even while interest rates languish at zero, and while unemployment is elevated. In fact, Say himself foresaw the possibility of massive involuntary unemployment and like Keynes and Bastiat, advocated public works programs to decrease unemployment. Indeed perhaps Say’s Law — at least in its post-Keynes incarnation — is more reflective of the ideas of Nassau Senior or David Ricardo than Jean-Baptiste Say.

Although the human sphere has always been driven to disequilibrium by the divergency of human plans and imaginations, prior to the industrial revolution — like in the time of Joseph and the Pharaoh — the possibility of involuntary unemployment (and starvation, etc) arising out of flood, robbery, famine, plague, drought, barbarian raids or some other externality was everywhere. The difference between the modern breakdowns in the Great Depression and the Post-2008 Depression and pre-industrial breakdowns of production is that the cause of the former is psychological (investors become grossly fearful of markets, etc, allowing resources to sit idle rather than being reallocated to productive uses) while the cause of the latter is actual material scarcity. But in the worst case the result is the same — needs and wants go unsatisfied and skills and trades stagnate. The outcomes of pre-industrial scarcity can seep into the post-industrial world through the channel of human psychology.

Keynes’ and Joseph’s recommendations on saving in the fat years to spend in the lean ones are ultimately apolitical in nature and apply just as much to the private sector as to the public sector. There is a widely-held conception that spending in the slump and saving in the boom is statist and favours central economic planning. This is not necessarily true. If a stateless society — let’s say, a future moon colony led by radical libertarians — becomes depressed, unemployment rises and resources lie idle, one solution to lift economic activity would be voluntary private infrastructure and capital spending. While Keynes himself rather unfortunately noted that “the theory of aggregated production… can be much easier adapted to the conditions of a totalitarian state”, infrastructure spending of private origin would be just as helpful in a depression in a stateless economy.

Yet Keynes sometimes pushed his arguments too far. Keynes suggested that “digging ditches is preferable to doing nothing” and proclaimed that the dawn of the Second World War meant that “the end of abnormal unemployment is in sight”. But wasting idle resources on unwanted projects like ditches or giant space lasers to repel a nonexistent alien invasion, or actively harmful projects like wars even though it may raise aggregate demand is still wasting resources. If the point of countercyclical policy is to avoid excessive levels of stagnation, it seems self-defeating to take idle resources and spend them on something entirely unwanted and unwarranted. Spending labour and capital on a destructive life-ending and infrastructure-destroying war rather than on useful infrastructural and scientific projects is akin to Pharaoh spending grain in a famine to support a war where just as many Egyptians die fighting as would have died in the averted famine.

So for successful countercyclical policy, I think it is important to emphasise quality projects that people actually want rather than simply emphasising aggregate levels of spending. In  Pharaoh’s Egypt, that was a store of grain…

Nietzsche, Austrianism, Neoclassicalism & Subjectivism

Corey Robin has an enormous, sprawling treatise at The Nation on the influence that Nietzsche may have had first on marginalist economics (Jevons, Walras, Menger) and second on modern free market economics:

The contributions of Jevons and Menger were multiple, yet each of them took aim at a central postulate of economics shared by everyone from Adam Smith to the socialist left: the notion that labor is a — if not the — source of value. Though adumbrated in the idiom of prices and exchange, the labor theory of value evinced an almost primitive faith in the metaphysical objectivity of the economic sphere — a faith made all the more surprising by the fact that the objectivity of the rest of the social world (politics, religion and morals) had been subject to increasing scrutiny since the Renaissance. Commodities may have come wrapped in the pretty paper of the market, but inside, many believed, were the brute facts of nature: raw materials from the earth and the physical labor that turned those materials into goods. Because those materials were made useful, hence valuable, only by labor, labor was the source of value. That, and the fact that labor could be measured in some way (usually time), lent the world of work a kind of ontological status—and political authority—that had been increasingly denied to the world of courts and kings, lands and lords, parishes and priests. As the rest of the world melted into air, labor was crystallizing as the one true solid.

There are, of course, great parallels between the Nietzschean subjectivism, and the subjectivism of Menger in particular.


Whatever has value in our world now does not have value in itself, according to its nature — nature is always value-less, but has been given value at some time, as a present — and it was we who gave and bestowed it.

And Menger:

Value is therefore nothing inherent in goods, no property of them, but merely the importance that we first attribute to the satisfaction of our needs, that is, to our lives and well-being.

Robin sees these theories as being anti-Marxist, anti-socialist, and anti-labour-theory-of-value in their origins as well as in their modern implications:

By the time the marginalists came on the scene, the most politically threatening version of the labor theory of value was associated with the left. Though Marx would significantly revise and recast it in his mature writings, the simple notion that labor produces value remained associated with his name—and even more so with that of his competitor Ferdinand Lasalle, about whom Nietzsche read a fair amount—as well as with the larger socialist and trade union movements of which he was a part. That association helped set the stage for the marginalists’ critique.

Admittedly, the relationship between marginalism and anti-socialism is complex. On the one hand, there is little evidence to suggest that the first-generation marginalists had heard of, much less read, Marx, at least not at this early stage of their careers. Much more than the threat of socialism underpinned the emergence of marginalist economics, which was as opposed to traditional defenses of the market as it was to the market’s critics. By the twentieth century, moreover, many marginalists were on the left and used their ideas to help construct the institutions of social democracy; even Walras and Alfred Marshall, another early marginalist, were sympathetic to the claims of the left. And on some readings, the mature Marx shares more with the constructivist thrusts of marginalism than he does with the objectivism of the labor theory of value.

On the other hand, Jevons was a tireless polemicist against trade unions, which he identified as “the best example…of the evils and disasters” attending the democratic age. Jevons saw marginalism as a critical antidote to the labor movement and insisted that its teachings be widely transmitted to the working classes. “To avoid such a disaster,” he argued, “we must diffuse knowledge” to the workers—empowered as they were by the vote and the strike—“and the kind of knowledge required is mainly that comprehended in the science of political economy.”

Menger interrupted his abstract reflections on value to make the point that while it may “appear deplorable to a lover of mankind that possession of capital or a piece of land often provides the owner a higher income…than the income received by a laborer,” the “cause of this is not immoral.” It was “simply that the satisfaction of more important human needs depends upon the services of the given amount of capital or piece of land than upon the services of the laborer.” Any attempt to get around that truth, he warned, “would undoubtedly require a complete transformation of our social order.”

Finally, there is no doubt that the marginalists of the Austrian school, who would later prove so influential on the American right, saw their project as primarily anti-Marxist and anti-socialist. “The most momentous consequence of the theory,” declared Wieser in 1891, “is, I take it, that it is false, with the socialists, to impute to labor alone the entire productive return.”

Whatever the originators and developers of the subjective theory of value — whether we mean Nietzschean cultural value, or Mengerian economic value — thought of the politics of the idea is rather irrelevant to me. The basic idea is correct and explanatory — that is, value is entirely in the eye of the beholder, and price is a function of a negotiation process fuelled by the conceptions of value — and any and all political conclusions are secondary to this fact. There were great political and social implications to the heliocentric model of the solar system — after all, that was just as controversial and politically divisive idea in its origins — but those political and social impllications have no bearing on whether the Earth travels around the Sun or vice versa. The same is true for the subjective theory of value and its ideological and political context.

But with great intellectual upheavals comes great resistance. Many so-called disciples of subjectivism have attempted to resurrect more objective approaches to value. That is, subjectivism’s greatest enemies may not have been advocates of the labour theory of value so much as self-described subjectivists who were repulsed by the supposed nihilism of subjectivism.

The neoclassical descendants of Walras and Jevons like Samuelson developed toybox mathematical models based around unrealistic (or semi-realistic) assumptions — rational preferences, utility maximisation, perfect competition, informationally efficient markets, etc. These act as an framework to objectify and rationalise human behaviour ruled not by static rationality but by fleeting, inconsistent subjectivity.

Equally the Austrian descendants of Menger like Mises and Hayek sought to depict the market as a framework as much for organising human morality — rewarding what they conceived of as good behaviour, and punishing what they conceived of as bad behaviour — as for allocating resources. As Hayek noted:

Until 130 or 150 years ago, everybody in what is now the industrialized part of the Western world grew up acquainted with the rules and necessities of what are called commercial or mercantile morals, because everyone worked in a small enterprise where he was equally concerned with, and exposed to, the conduct of others. Whether as master or servant or member of the family, everybody accepted the unavoidable necessity of having to adapt himself to changes in demand, supply, and prices in the marketplace. A change began to happen in the middle of the last century. Where previously perhaps only the aristocracy and its servants were strangers to the rules of the market, the growth of large organizations in business, commerce, finance, and ultimately in government, increased the number of people who grew up without being taught the morals of the market which had been developed in the course of the preceding 2,000 years.

For probably the first time since classical antiquity, an ever-increasing part of the population of the modern industrial state grew up without learning in childhood that it was indispensable to respond as both producer and consumer to all the unpleasant things which the changing market required. This development coincided with the spreading of a new philosophy, which taught people that they ought not to submit to any principle of morals which could not be rationally justified.

To a Nietzschean — or any subjectivist — notions of good behaviour and bad behaviour are as much in the eye of the beholder as the values of commodities. Indeed, that is their crux — humans act in the human spheres of morality and commerce because humans are value-creating! Living out our subjective desires, painting or judging the world with our subjective morals and ethics, and meeting our subjective goals is not a matter of hedonism, but the inevitable consequence of humanity.

These two groups of prescriptive counter-revolutionaries — the Samuelsonian neoclassicals and their objectifying assumptions, and the Misesian Austrians and their moral absolutism — may have turned back the subjectivist revolution to a great degree, but their victory has not been absolute. Some neoclassical economists like Hal Varian seem to have reversed Samuelsonian optimisation into “doing whatever an agent wants”, which is entirely compatible with a subjectivist conception of value. And some Austrians and Post-Keynesians like Ludwig Lachmann and George Shackle have explored subjective economics deeply, looking at the role of discordant expectations and imaginations as a fuel for disequilibrium.

Most importantly, behavioural economics — which is largely descriptive — seeks to understand economics not from the basis of preordained theory and assumptions, but in terms of how agents and systems actually behave in various situations. Ultimately, through the nonjudgmental study of human action we may finally arrive at an economics that reflects value as it really is, and how it was understood by Nietzsche and Menger — as a product of the minds, eyes and hearts of humans.

On the Relationship Between the Size of the Monetary Base and the Price of Gold

The strong correlation between the gold price, and the size of the US monetary base that has existed during the era of quantitative easing appears to be in breakdown:


To emphasise that, look at the correlation over the last year:


Of course, in the past the two haven’t always been correlated. Here’s the relationship up to 2000:


So there’s no hard and fast rule that the two should line up.

My belief is that the gold price has been driven by a lot of moderately interconnected factors related to distrust of government, central banks and the financial system — fear of inflation, fear of counterparty risk, fear of financial crashes and panics, fear of banker greed and regulatory incompetence, fear of fiat currency and central banking, belief that only gold (and silver) can be real money and that fiat currencies are destined to fail. The growth in the monetary base is intimately interconnected to some of these — the idea that the Fed is debasing the currency, and that high or hyperinflation or the failure of the global financial system are just around the corner. These are historically-founded fears — after all, financial systems and fiat currencies have failed in the past. Hyperinflation has been a real phenomenon in the past on multiple occasions.

But in this case, five years after 2008 these fears haven’t materialised. The high inflation that was expected hasn’t materialised (at least by the most accurate measure). And in my view this has sharpened the teeth of the anti-gold speculators, who have made increasingly large short sales, as well as the fears of some gold buyers who bought a hedge against something that hasn’t materialised. The global financial system still possesses a great deal of systemic corruption, banker greed and regulatory incompetence, and the potential for future financial crashes and blowups, so many gold bulls will remain undeterred. But with inflation low, and the trend arguably toward deflation (especially considering the shrinkage in M4 — all of that money the Fed printed is just a substitute for shrinkage in the money supply from the deflation of shadow finance!) gold is facing some strong headwinds.

And so a breakdown in the relationship between the monetary base has already occurred. Can it last? Well, that depends very much on individual and market psychology. If inflation stays low and inflation expectations stay low, then it is hard to see the market becoming significantly more bullish in the short or medium term, even in the context of high demand from China and India and BRIC central banks. The last time gold had a downturn like this, the market was depressed for twenty years. Of course, those years were marked by large-scale growth and great technological innovation. If new technologies — particularly in energy, for example if solar energy becomes cheaper than coal — enable a new period of spectacular growth like that which occurred during the last gold bear market, then gold is poised to fall dramatically relative to output.

But even if technology and innovation does not produce new organic growth, gold may not be poised for a return to gains. A new financial crisis would in the short term prove bearish for gold as funds and banks liquidate saleable assets like gold. Only high inflation and very negative real interest rates may prove capable of generating a significant upturn in gold. Some may say that individual, institutional and governmental debt loads are now so high that they can only be inflated away, but the possibility of restructuring also exists even in the absence of organic growth. A combination of strong organic growth and restructuring would likely prove deadly to gold.