inflation

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The Welfare Kings of Europe

In spite of the fact that 85% of Greeks want to stay in the Eurozone, I was reasonably confident that Greeks would support Syriza to a first-place finish, and elect a new government willing to play chicken with the Germans. However Greeks — predominantly the elderly — rejected change (and possible imminent Drachmatization) in favour of the fundamentally broken status quo.

But although Syriza finished second, the anti-bailout parties still commanded a majority of the votes.

And New Democracy may still face a lot of trouble building a coalition to try to keep Greece in the bailout, and in the Euro . There has long been a rumour that Tsipras wanted to lose, so as to (rightly) blame the coming crush on the status quo parties. What fewer of us counted on was that the status quo parties wouldn’t want to win the election either. The pro-bailout socialists Pasok have thrown a monkey wrench into coalition-building by claiming they won’t take part in any coalition that doesn’t also include Syriza. This seems rational; when the tsunami hits, all parties in government will surely take a lot of long-term political damage. Pasok have already been marginalised by the younger and fierier Syriza, and Pasok presiding over an economic collapse (for that is undoubtedly what Greece now faces) would surely have driven Pasok into an abyss. The economy is such a poisoned chalice that parties seem willing to fight to keep themselves out of power.

And with more austerity, it’s only going to get worse. Once a society is hooked on large-scale debt-fuelled state spending, austerity in the name of government deleveraging is tough enough when the economy is booming, but during a depression as spending falls, tax revenues fall, very often producing (as has been the case in Greece, Spain, Portugal and the UK) even bigger deficits.

So let us not forget who the most welfare-dependent nations (i.e. the ones who would be hurt the most by attempting an austerity program during an economic depression) are in Europe (clue — it’s not Greece):

International economics is a fast game. It’s only sixty years since America was exporter and creditor to the world. It’s only fifteen years since the now-booming German economy was described as the “sick man of Europe”.

The same Euro system that is slamming Greece, Portugal, Spain and Italy today — in the aftermath of bubbles caused by easy money flowing into these countries as a result of the introduction of the Euro — could (if it were to somehow survive)  do the same thing to Germany in ten or twenty or thirty years.

A monetary union without a fiscal union is a fundamentally unworkable system and Westerwelle, Schauble and Merkel insisting that Greece play by the rules of their game is just asking for trouble. And trying to introduce a fiscal union over a heterogeneous, tense and disagreeable land as Europe is just asking for political trouble.

No matter how many nations are browbeaten by fear into committing to the status quo, it still won’t be sustainable. Greeks (and the other peripheral populations) can commit to austerity from here to eternity, but it won’t stop those policies resulting in deeper contraction, and more economic catastrophe.

But the collapse of the Euro would at most-recent estimates cost the core and particularly Germany a lot more than handing over the money to the PIGS. Eventually they will hand over the money to shield themselves from falling masonry. The real question is whether or not the entire system will spiral into pandemonium before Germany blinks.

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What Peak Oil?

Is peak oil imminent? Lots of people seem to think so.

The data (released by BP a company who have a vested interest in oil scarcity) don’t agree. Proved reserves keep increasing:

The oil in the ground will run out some day. But as the discovery of proven reserves continues to significantly outpace the rate of extraction, the claims that we’re facing immediate shortages looks trashy.

Some may try to cast doubt on these figures, saying that BP are counting inaccessible reserves, and that we must accept that while there are huge quantities of shale oil in the ground, the era of cheap and readily accessible oil is over. They might cite the idea that oil prices are much higher than they were ten years ago. Yet this is mostly a monetary phenomenon resulting from excessive money creation beyond the economy’s productive capacity. Priced in gold, oil is still very cheap — almost as cheap as it has ever been:

The argument that the vast majority of counted reserves are economically inaccessible is fundamentally flawed. In the long run there is only one equation that really matters in determining whether oil is extractable, and that is whether there is a net energy gain; whether energy-in exceeds energy-out. If there’s a net energy gain, it’s feasible. Certainly, we are moving toward a higher cost of energy extraction. Shale oil (for example) has a lower net energy gain than conventional oil, but still typically produces five times as much energy as is consumed in extraction.

But the Earth’s extractable hydrocarbons will eventually dry up, whether that’s in 500 years or 200 years. If we want humanity to have a long-term future on Earth, we need to move to renewables; solar, hydroelectric, thorium, synthetic hydrocarbons. And the market will ensure that, eventually — as the cost of renewable energy continues to fall, more and more of us will adopt it. I don’t buy the myth that markets are stupid — if humanity needs renewable energy (I believe we do) the market will see to it (I believe that is slowly happening). Markets are just the sum of human preferences.

According to the International Renewable Energy Institute:

Power from renewable energy sources is getting cheaper every year, according to a study released Wednesday, challenging long-standing myths that clean energy technology is too expensive to adopt. The costs associated with extracting power from solar panels has fallen as much as 60 percent in just the past few years.The price of  from other renewables, including wind, , concentrating solar power and biomass, was also falling.

So no. I’m not lying awake at night worrying about imminent peak oil. There’s plenty of extractable oil, and renewable energy will eventually supplement and replace it. But will politics get in the way of energy extraction? The United States has huge hydrocarbon reserves, yet regulation is preventing drilling and shipment, leaving America dependent on foreign oil. And the oil companies themselves are largely to blame — after Deepwater Horizon, should anyone be surprised that politicians and the public want to strangle the oil industry?

If there’s an imminent energy crisis, it will be man-made. It will come out of the United States’ dependency on foreign oil. Or out of an environmental catastrophe caused by mismanagement and graft (protected cartels like the energy industry always lead to mismanagement). Or out of excessive red tape. Or war.

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Inflationeering

As BusinessWeek asked way back in 2005 before the bubble burst:

Wondering why inflation figures are so tame when real estate prices are soaring? There is a simple explanation: the Consumer Price Index factors in rising rents, not rising home prices.

Are we really getting a true reading on inflation when home price appreciation isn’t added into the mix? I think not.

I find the idea that house price appreciation and depreciation is not factored into inflation figures stunning. For most people it’s their single biggest lifetime expenditure, and for many today mortgage payments are their single biggest monthly expenditure. And rental prices (which are substituted for house prices) are a bad proxy. While house prices have fallen far from their mid-00s peak, rents have continued to increase:

Statisticians in Britain are looking to plug the hole. From the BBC:

A new measure of inflation is being proposed by the Office for National Statistics (ONS).

It wants to create a version of the Consumer Prices Index that includes housing costs, to be called CPIH.

The ONS wants to counteract criticisms that the main weakness of the CPI is that it does not reflect many costs of being a house owner, which make up 10% of people’s average spending.

While a welcome development (and probably even more welcome on the other side of the Atlantic) it doesn’t make up for the fact that the explosive price increases during the boom years were never included. And it isn’t just real estate — equities was another market that massively inflated without being counted in official inflation statistics. It would have been simple at the time to calculate the effective inflation rate with these components included. A wiser economist than Greenspan might have at least paid attention to such information and tightened monetary policy to prevent the incipient bubbles from overheating.

Of course, with inflation statistics calculated in the way they are (price changes to an overall basket of retail goods) there will always be a fight over what to include and what not to include.

A better approach is to include everything. Murray Rothbard defined inflation simply as any increase to the money supply; if the money is printed, it is inflation. This is a very interesting idea, because it can reflect things like bubble reinflation that are often obscured in official data. The Fed has tripled the monetary base since 2008, but this increase in the monetary base has been offset against the various effects of the 2008 crash, which triggered huge price falls in housing and equities which were only stanched when the money printing started.

Critics of the Austrian approach might say that it does not take into account how money is used, but simply how much money there is. An alternative approach which takes into account all economic activity is nominal GDP targeting, whereby monetary policy either tightens or loosens to achieve a nominal GDP target. If the nominal target is 1%, and GDP is growing at 7%, monetary policy will tighten toward 1% nominal growth. If GDP is growing at a negative rate (say -2%), then the Fed will print and buy assets ’til nominal GDP is growing at 1%. While most of the proponents of this approach today tend to be disgruntled Keynesians like Charles Evans who advocate a consistent growth rate of around 5% (which right now would of course necessitate the Fed to print big and buy a lot of assets, probably starting with equities and REITs), a lower nominal GDP target — of say, 1% or 2% — would certainly be a better approach to the Fed’s supposed price stability mandate than the frankly absurd and disturbing status quo of using CPI, which will always be bent and distorted by what is included or not included. And for the last 40 years monetary policy would have been much, much tighter even if the Fed had been pursuing the widely-cited 5% nominal GDP target.

I don’t think CPI can be fixed. It is just too easy to mismeasure inflation that way. Do statisticians really have the expertise to determine which inflations to count and which to ignore? No; I don’t think they do. Statisticians will try, and by including things like house prices it is certainly an improvement. But if we want to be realistic, we must use a measure that reflects the entire economy.

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Treasuries Still Not Cracking

Tyler Durden pointed out yesterday that just three weeks after Goldman made the case for equities relative to bonds, the muppets who had listened to their advice were getting skewered:

I wrote a while back that (unlike some others) I didn’t believe it was likely that  this was going to be a cataclysmic rate spike. Readers who want to detect one need to watch whether sovereign creditors especially Russia and China are selling, and at what pace — the faster the liquidation, the more rates may spike.

Of course, I am still convinced that the real fragility to America’s economy isn’t actually a rate spike or inflation.The Fed has a very good handle on both of these things (but not, perhaps on unwanted side effects. They can effectively do QE without really inflating the currency much; simply shoot the money to primary dealers for treasuries.

When volatility is artificially suppressed, there are always unwanted side effects. And that — the unwanted side effects, not the widely-reported fears of inflation and rate spikes — I believe, is the true danger.

One unwanted side effect could be provoking a damaging trade war with China, from which the West imports so much. That is my pet theory, and one I’ve devoted a few thousand words to over the last few months. But the trouble with side-effects is that it is very hard to tell what the weakest link (i.e. the point that will break) in a volatility-suppressed system is. Tyler Durden reports that systemic financial fragility (as measured by CDS) is at a recent-high, too:

Believers in technical analysis (I am very sceptical) are pointing to a head-and-shoulders top in the “recovery” (to go with the bigger head and shoulders top that is very much one of the stories of the last ten years):

I don’t know when the black swans will come home to roost and the strange creature that we call the present global economic order will go ka-put. I don’t even know if they ever will! But I see the fragilities caused by central planners suppressing the system’s natural volatility.

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Price Stability?

Yeah.

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Great Success!

From Business Insider:

The Federal Reserve Open Market Committee (FOMC) has made it official: After its latest two day meeting, it announced its goal to devalue the dollar by 33 percent over the next 20 years. The debauch of the dollar will be even greater if the Fed exceeds its goal of a 2 percent per year increase in the price level.

Regular readers will know that I believe that the dollar in its present form is extremely unlikely to exist in twenty years, due to the systemic fragilities of a system softened up by forty years of unrestrained credit creation, securitisation, (including over a quadrillion dollars of derivatives), and a free lunch of Arabian oil and Asian goods rolling off the printing press.

But in any case, let’s have a look at just how successful the FOMC has been in debasing the dollar:

Past performance shows the only way is down, down, down.

After all, the FOMC central planners determined long ago that deflation — a natural phenomenon that has occurred repeatedly throughout history, and which actually has a useful function of liquidating bad businesses and debts — was bad, and that they were going to print, print, print ’til it was eradicated.

Does anyone else think that there might be things worse than deflation?

Like — oh, I don’t know — currency collapse?

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Sinking Beneath the Waves

Last month, I gave up writing about the European meltdown. After all, it was all so inevitable. Either Europe will take the slow and painful Japanese-American road to zombification (allowing a broken system to continue to be broken) by printing the money to support debt levels or European nations like Greece will default and all hell will break loose.

As I wrote multiple times last year, I believed the latter was far likelier, mainly because I didn’t think Germans wouldn’t stand for printing money, although so far it appears that I have been wrong.

Today Zero Hedge brings some confirmation that stern Teutonic monetarism is here to stay, and there is no Euro-Bernanke:

Today channeling the inscription to the gates of hell from Dante’s inferno is none other than yet another Bundesbank board member, Carl-Ludwig Thiele, who said that “Europe must abandon the idea that printing money, or quantitative easing, can be used to address the euro zone debt crisis. One idea should be brushed aside once and for all — namely the idea of printing the required money. Because that would threaten the most important foundation for a stable currency: the independence of a price stability orientated central bank.”

Fitch meanwhile believe that the Greek default will be here by March:

Greece is insolvent and probably won’t be able to honor a bond payment in March as the country negotiates with creditors to cut its debt burden, Fitch Ratings Managing Director Edward Parker said.

The euro area’s most indebted country is unlikely to be able to honor a March 20 bond payment of 14.5 billion euros ($18 billion), Parker said today in an interview in Stockholm. Efforts to arrange a private sector deal on how to handle Greece’s obligations would constitute a default, he said.

As we learned a long time ago, big defaults on the order of billions don’t just panic markets. They congest the system, because the system is predicated around the idea that everyone owes things to everyone else. The $18 billion that Greece owes to the banks are in turn owed on to other banks and other institutions. Failure to meet that payment doesn’t just mean one default, it could mean many more. The great cyclical wheel of international debt is only as strong as its weakest link.

This kind of breakdown is known as a default cascade. In an international financial system which is ever-more interconnected, we will soon see how far the cascade might travel.

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Stiglitz vs Krugman

A very interesting front is opening up regarding the current state of America.

Some economists believe that the main problem in America is a lack of demand, defined as the desire to buy, the willingness to buy, and the ability to pay for it

From Paul Krugman:

There is nothing — nothing — in what we see suggesting that this current depression is more than a problem of inadequate demand. This could be turned around in months with the right policies. Our problem isn’t, ultimately, economic; it’s political, brought on by an elite that would rather cling to its prejudices than turn the nation around.

The implication here is that people just don’t have the money in their pockets to spend at the levels they were five years ago, and the solution is (through whatever means) giving them that money.

As well as the obvious (and accurate) Austrian retort that demand in 2006 was being pushed skyward as part of a ridiculous and entirely artificial debt-financed bubble, other economists believe that a lack of demand is just a symptom of other underlying symptoms. I myself believe that the three main problems are a lack of confidence stemming from high systemic residual debt, deindustrialisation in the name of globalisation (& its corollary, financialisation and that sprawling web of debt and counter-party risk), and fragility and side-effects (e.g. lost internal productivity due to role as world policeman) coming from America’s petroleum addiction.

Now Joe Stiglitz has weighed in in a lengthy and essential Vanity Fair piece:

The trauma we’re experiencing right now resembles the trauma we experienced 80 years ago, during the Great Depression, and it has been brought on by an analogous set of circumstances. Then, as now, we faced a breakdown of the banking system. But then, as now, the breakdown of the banking system was in part a consequence of deeper problems. Even if we correctly respond to the trauma—the failures of the financial sector—it will take a decade or more to achieve full recovery. Under the best of conditions, we will endure a Long Slump. If we respond incorrectly, as we have been, the Long Slump will last even longer, and the parallel with the Depression will take on a tragic new dimension.

Many have argued that the Depression was caused primarily by excessive tightening of the money supply on the part of the Federal Reserve Board. Ben Bernanke, a scholar of the Depression, has stated publicly that this was the lesson he took away, and the reason he opened the monetary spigots. He opened them very wide. Beginning in 2008, the balance sheet of the Fed doubled and then rose to three times its earlier level. Today it is $2.8 trillion. While the Fed, by doing this, may have succeeded in saving the banks, it didn’t succeed in saving the economy.

Reality has not only discredited the Fed but also raised questions about one of the conventional interpretations of the origins of the Depression. The argument has been made that the Fed caused the Depression by tightening money, and if only the Fed back then had increased the money supply—in other words, had done what the Fed has done today—a full-blown Depression would likely have been averted. In economics, it’s difficult to test hypotheses with controlled experiments of the kind the hard sciences can conduct. But the inability of the monetary expansion to counteract this current recession should forever lay to rest the idea that monetary policy was the prime culprit in the 1930s. The problem today, as it was then, is something else. The problem today is the so-called real economy. It’s a problem rooted in the kinds of jobs we have, the kind we need, and the kind we’re losing, and rooted as well in the kind of workers we want and the kind we don’t know what to do with. The real economy has been in a state of wrenching transition for decades, and its dislocations have never been squarely faced. A crisis of the real economy lies behind the Long Slump, just as it lay behind the Great Depression.

At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century—better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

What this transition meant, however, is that jobs and livelihoods on the farm were being destroyed. Because of accelerating productivity, output was increasing faster than demand, and prices fell sharply. It was this, more than anything else, that led to rapidly declining incomes. Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn’t pay back what they owed. The financial sector was swept into the vortex of declining farm incomes.

The cities weren’t spared—far from it. As rural incomes fell, farmers had less and less money to buy goods produced in factories. Manufacturers had to lay off workers, which further diminished demand for agricultural produce, driving down prices even more. Before long, this vicious circle affected the entire national economy.

The parallels between the story of the origin of the Great Depression and that of our Long Slump are strong. Back then we were moving from agriculture to manufacturing. Today we are moving from manufacturing to a service economy. The decline in manufacturing jobs has been dramatic—from about a third of the workforce 60 years ago to less than a tenth of it today. The pace has quickened markedly during the past decade. There are two reasons for the decline. One is greater productivity — the same dynamic that revolutionized agriculture and forced a majority of American farmers to look for work elsewhere. The other is globalization, which has sent millions of jobs overseas, to low-wage countries or those that have been investing more in infrastructure or technology. (As Greenwald has pointed out, most of the job loss in the 1990s was related to productivity increases, not to globalization.) Whatever the specific cause, the inevitable result is precisely the same as it was 80 years ago: a decline in income and jobs. The millions of jobless former factory workers once employed in cities such as Youngstown and Birmingham and Gary and Detroit are the modern-day equivalent of the Depression’s doomed farmers.

The consequences for consumer spending, and for the fundamental health of the economy — not to mention the appalling human cost—are obvious, though we were able to ignore them for a while. For a time, the bubbles in the housing and lending markets concealed the problem by creating artificial demand, which in turn created jobs in the financial sector and in construction and elsewhere. The bubble even made workers forget that their incomes were declining. They savored the possibility of wealth beyond their dreams, as the value of their houses soared and the value of their pensions, invested in the stock market, seemed to be doing likewise. But the jobs were temporary, fueled on vapor.

So far, so excellent. Stiglitz first shovels shit over the view of Fisherian debt-deflation as the main cause of the slump in demand — debt-deflation is a symptom, and a very nasty one, but not really a cause. Second, Stiglitz also correctly notes that today’s ailments are the result of social, infrastructural and productive upheaval in the real economy. He correctly identifies the leading trend here — manufacturing (and, it should be added, primary industry) has been ripped out of America by the forces of globalisation, and the powerful pull of cheaper wages. This is a strong explanation of why Krugman’s view — that the only thing missing is demand, and that government can fix that in an instant — is nonsense.

As I wrote earlier this month:

The point here is that economic health — and real industrial output, measured in joules, or in “needs met” — and money circulation are in reality almost totally decoupled. Getting out of a depression requires debt erasure, and new organic activity, and there is absolutely no guarantee that monetary easing will do the trick on either count. Most often, depressions and liquidity traps are a reflection of underlying structural and sociological problems, and broken economic and trade systems. Easing kicks the can down the road a little, and gives some time and breathing room for those problems to be fixed, but very often that just doesn’t happen. Ultimately, societies only take the steps necessary (e.g. a debt jubilee) when their very existence seems threatened.

Stiglitz continues:

What we need to do instead is embark on a massive investment program—as we did, virtually by accident, 80 years ago—that will increase our productivity for years to come, and will also increase employment now. This public investment, and the resultant restoration in G.D.P., increases the returns to private investment. Public investments could be directed at improving the quality of life and real productivity—unlike the private-sector investments in financial innovations, which turned out to be more akin to financial weapons of mass destruction.

Now, I don’t really have a problem with the idea that government can do some good. If people in a democracy choose to solve problems via public spending, well, that’s part of the bargain in a democratic state. Even Adam Smith noted that government should fund “certain great institutions” beyond the reach of private enterprise.

But here we reach the great problem with Stiglitz’s view:

The private sector by itself won’t, and can’t, undertake structural transformation of the magnitude needed—even if the Fed were to keep interest rates at zero for years to come. The only way it will happen is through a government stimulus designed not to preserve the old economy but to focus instead on creating a new one. We have to transition out of manufacturing and into services that people want — into productive activities that increase living standards, not those that increase risk and inequality.

The United States spent the last decade (arguably longer) and trillions of dollars embroiled in wars aimed at keeping oil cheap, and maintaining the flow of global goods precisely because America is dependent upon those things. America does not play global policeman out of nicety or vanity — she does it out of economic necessity. That is precisely because America let globalisation take away all of her industry, making her dependent not only on the continued value of her paper dollar, but on the flow of global trade in energy and goods.

Investing more money in services will leave America dependent on these contingencies. And dependency is fragility — and the more fragile America becomes, the more aggressive she becomes in maintaining and controlling the flow of global goods.

Any stimulus package ought to instead be focussed on making America energy independent, and encouraging innovative new forms of manufacturing (e.g. 3-D printing) that can undercut Chinese labour.

So while Stiglitz must be commended for seeing through the haze, it is rather puzzling that his alternative is services, rather than self-sufficiency.

While America is dependent on foreign goods and energy, she is prone to not only waste huge amounts of productive capital on war and weapons, but she also risks serious economic damage from events such as oil shocks, geopolitical shocks, regional wars, and — well — anything that might slow down or endanger global trade. Her need to police the world makes her even hungrier for oil, which means she spends more money on the world, which makes her hungrier for oil.

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Inflating Away the Debt?

Some commentators believe that the best way for Greece — and by extension, everyone with a debt problem — to deal with debt is introducing some mild-to-moderate inflationary pressure (or least, the expectation of such a thing).

The problem is, the evidence (thanks to regular reader Andrei Canciu) suggests this isn’t in the least bit effective:

The real solution for the terminally indebted is not to get into debt in the first place. Once you are there, the pressure of creditors means that the chosen path will generally be a succession of unsuccessful Keynesian can-kicks (or, in Europe, crushing austerity) up to a slow, painful default.

As Keynes put it:

The boom, not the slump, is the right time for austerity at the Treasury.

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The Abolition of Deflation

Modern economics has been a great experiment:

Economic history can be broadly divided into two eras: before Keynes, and after Keynes. Before Keynes (with precious metals as the monetary base) prices experienced wide swings in both directions. After Keynes’ Depression-era tract (The General Theory) prices went in one direction: mildly upward. Call that a victory for modern economics, central planning, and modern civilisation: deflation was effectively abolished. The resultant increase in defaults due to the proportionate rise in the value of debt as described by Irving Fisher, and much later Ben Bernanke, doesn’t happen today. And this means that creditors get their pound of flesh, albeit one that is slightly devalued (by money printing), as opposed to totally destroyed (by mass defaults).

But (of course) there’s a catch. Periods of deflation were painful, but they had one very beneficial effect that we today sorely need: the erasure of debt via mass default (contraction of credit means smaller money supply, means less money available to pay down debt). With the debt erased, new organic growth is much easier (because businesses, individuals and governments aren’t busy setting capital aside to pay down debt, and therefore can invest more in doing, making and innovating). Modern economics might have prevented deflation (and resultant mass defaults), but it has left many nations, companies and individuals carrying a great millstone of debt (that’s the price of “stability”):

The aggregate effect of the Great Depression was the erasure of private debt by the end of World War 2. This set the stage for the phenomenal new economic growth of the 50s and 60s. But since then, there’s been no erasure: only vast, vast debt/credit creation.

As I have long noted, in the end the debt load will have to be erased, either by direct default (or debt jubilee), or by indirect default (hyperinflation). Deleveraging in a credit-based economy, is very, very difficult to achieve, without massive damage to GDP (due to productive capital being lost to debt repayment). The irony is that the more central banks print, and the more the Krugmanites advocate for stimulus, the tetchier creditors (i.e., China) become about their holdings being debased, when the reality is that the only hope that they have to see any return on their debt holdings is for governments to print, print, print.

How long can America and the world kick the can? As long as the productive parts of the world — oil exporters, and goods manufacturers — allow the unproductive parts of the world — consumers and “knowledge economies” — to keep getting a free lunch. Keynesian economics didn’t abolish defaults in the long run — it just succeeded at making mass defaults much less frequent. My hypothesis is that it also made these moments of default much more catastrophic.

This is akin to the effects of dropping rocks on humans: drop a hundred 1-pound-rocks on a man over the course of 50 years  (at the rate of two per year) and he will most likely be alive after those years. Drop one hundred-pound-rock on him after fifty years and he will more likely be dead aged 50. Perhaps in reality it is not as extreme as that, but that is the principle: frequent small defaults, small depressions, and small contractions have been abolished, in favour of occasional very, very big depressions, contractions and defaults.

Where does that leave Keynesian economics?

Well Keynes was right that intervention can save lives, families and businesses. What Keynes and Fisher were wrong about is that stabilising credit markets and prices (resulting in the abolition of deflation) is completely the wrong kind of intervention. Government’s role during depressions is to preserve and stabilise the productive (i.e. physical) economy, to prevent the needy from starving, to prevent homelessness, and create enough infrastructure for the nation to function (and eventually, to thrive). The financial economy (and all the debt) should go the way nature intends — erasure, and resurrection (in a new form).