Ding Dong the Coin Is Dead

I laughed a lot when it was announced that Obama wasn’t going to mint a platinum coin and effectively render the debt ceiling obsolete. And not because I hope for or expect the USA to immediately and chaotically default. Not because I expect the Federal government to not raise the debt ceiling again.

I laughed a lot because the platinum coin was a very, very silly idea. I laughed a lot because there was no clue of any such event taking place. It was a pure myth talked into prominence by Business Insider for pageviews and advertising dollars, and by other bloggers who should have known better.

Bruce Krasting writes that the platinum coin was killed by foreign central banks who thought it would set a dangerous precedent, and ultimately by Ben Bernanke:

It was the Fed, in a message delivered by Bernanke, that caused Obama to back off on any consideration of the Coin. There might have been wiggle room in existing law to print a Coin, but there is nothing that says that the Fed had to take it. And Bernanke said, “No”. When Obama ditched the Coin, he did it because it was no longer an option. Bernanke took the option off the table. The WH statement makes it sound as it it was their decision, that’s just smoke and mirrors.

I don’t even think it got that far.

As I wrote last week:

I think all parties other than the pundits thought the idea was ridiculous and totally unpalatable. For both Obama and Boehner — and especially Bernanke — negotiating a settlement is far, far more attractive than the signals of fiscal disarray that would have been sent by minting the platinum coin. Not to mention that minting a platinum coin and depositing it at the Fed to avert the debt ceiling would have been open to serious legal challenge. Compromise was the order of the day in 2011, and on the fiscal cliff, and it will be the order of the day on the debt ceiling again.

The people who advocated for the platinum coin were mostly doing so because they don’t like compromise. They wanted their side to effectively steamroller the other side into total submission. Right or wrong, that’s not how politics works. A deal will be done. It may not be a deal that Krugman, or Weisenthal, or Boehner, or Obama or Ron Paul or the country in general really likes, though.

Krugman Claims He Has Been Right About Everything

I don’t think Krugman’s descriptive work on global trade patterns is bad. I don’t even think he has been completely wrong about the post-2008 economic depression. He certainly hasn’t been wronger than the people who are in charge in Europe, or the people running the Fed; he did, after all warn in 2005 that the Fed was “running out of bubbles” to reinflate, while Bernanke was still claiming in 2007 that subprime was contained.

I do think his defence of broken windows is facile, and I think the notion he has advanced that World War 2 ended the Great Depression is not just wrong but dangerous.

He’s a good polemicist; he defines himself through big, bold, wildly partisan claims. But if he’s going to claim that he’s been right about everything — as he just did — he might want to make sure he’s not directly contradicting statements he made just a week previous.

On June 18th Krugman posited:

I (and those of like mind) have been right about everything.

However on June 11th Krugman wrote:

People like me may not have been right about everything, but have accumulated a pretty darn good track record over the past 5 years.

So, um, which is it?

Nobody can be right about everything. Claiming that you have been is just silly hyperbole which will end up making you look bad especially when your record is, in reality, quite mixed. And if his goal is to convince policy-makers to ditch austerity (a goal that I share, at least for the time-being), he’s not going to do it by sticking his foot in his mouth.

There is No Such Thing as a Service Economy

It is often said that prostitution is the oldest profession. This is not true, and I know this with a very high degree of certainty. For a prostitute to subsist, there must be  a medium of exchange, and for a medium of exchange to exist — even in terms of barter — there must be a surplus of production (i.e. a person is producing more than they can consume). Thus, there must be pre-existing productivity, for example food that has been hunted, or gathered or grown, tools that have been created, etc.

The truth is that prostitution (or perhaps soldiery) is probably the oldest service profession.

What is a service profession? Well broadly there are two kinds of professions: goods-producing, and services-producing. Goods-producing professions produce things. Services-producing professions do things without producing any definable goods. Prostitution is a very good example. So is legal work, consulting, lobbying, graphic design, sales work, soldiery, musicianship, acting, etc. And yes — while I feel that writing creates a good — it too is widely considered a service.

At present, the Western economies are dominated by services.

From the World Bank:

Joe Sitglitz’s article in Vanity Fair late last year argued that we need to move even further into a service-led economy:

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.

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.

Now I’m not accusing Stiglitz of anything other than a misplaced zeal for fixing the American economy. His suggestion is merely emblematic of a wider misconception.

Service jobs come into existence as there are bigger surpluses of production. In an isolated national economy, the services sector will only grow if the productive sector grows in proportion. But in a global economy, with flows of trade and goods, illusions are possible.

The truth is that there is no such thing as a service economy. Our economy today (other than in places like, say, North Korea) is truly global. All of those service workers — and every cent of “services” GDP — is supported by real-world productivity, much of which takes place outside the West — the productivity of the transport system, the productivity of manufacturers, the productivity of agriculture.

The continued prosperity of the West is dependent on the continued flow of goods and services into the West.

This is an intentionally zany example (but certainly no less zany than Krugman’s babysitting co-op) of how moving to a “service-based” (pun-intended, you’ll see) economy can prove detrimental:

Imagine the centrally-planned society of War-is-Peace-Land, occupying one half of a large island, and led by an absolute King. The kingdom is very successful in warfare, and maintains a great advantage over its sole neighbour. 50% of its working subjects are conscripted into the military, in various roles — soldiery, tactics, smithing, horsemanship, etc. Of the other half of the population 30% work in collective agriculture, 10% work in light industry (e.g. making candles) and 10% are personal servants to the King (or in the case of females part of his large harem). Now, the King does not like the fact that his harem is not as large as it could be; he does not like that there are women and girls toiling the fields when they could be in his harem. Nor does he like that there are men toiling in the fields when they could instead be conscripted into the military.

Fortunately in the neighbouring kingdom of Productivity Land, they have huge surpluses of agriculture and productivity, as only 30% of their population is conscripted into the military, while 40% work in agriculture, and 20% in light industry. As they make such huge surpluses, they are willing to make up for any shortfall in War-is-Peace-Land. As a result of this, more and more workers in War-is-Peace-Land can be moved from agriculture to serving the King, either as a manservant (carrying his Royal chair, beating up anyone who insults him, tending to his elaborate gardens) or as a member of his harem. In return for this, the King sends promissory notes — which are often promptly lent back —  from Productivity Land to pay for their products. Productivity Land uses this money to acquire natural resources from other islands.

Eventually, the King decides that his pleasure gardens need to be greatly expanded, and so he moves the entire non-military workforce out of agriculture, and into manufacture terra cotta and bronze statues, to decorate his pleasure gardens. Of course, War-is-Peace Land has built up a humungous debt over the years, and Productivity Land feels short-changed in sending its productive output across to the other half of the island in exchange for increasingly-devalued pieces of fiat paper that buy increasingly less and less resources. But the King of Productivity Land is very smart. He recognises that winning a military confrontation with War-is-Peace Land will still be difficult, so he agrees to continue this arrangement so as to make War-is-Peace Land even more deeply dependent upon the produce of Productivity Land. 

One day, the King of War-is-Peace Land was out frolicking gaily in his pleasure gardens, smoking his pipe and contemplating a lazy afternoon molesting his harem. Alas, no. A messenger from Productivity Land arrived at the Palace to inform him that Productivity Land was sick of his devalued fiat currency, and so would no longer send agricultural products or other produce. That was it — War-is-Peace Land had no intent to pay back their debt, so they were out in the cold.

Nonsense!” cried the King, and promptly had the messenger arrested, tortured and killed. He rallied his generals, and declared war against Productivity Land. Alas, they did not get very far. It took three days for the army to be rallied together into a fighting force, and by that time War-is-Peace Land was running low on food and fuel. Armies — no matter how well-equipped — cannot march on an empty stomach. The tired and weary soldiers of War-is-Peace Land were more numerous and better equipped, but their hunger and subsequent tiredness got the better of them and they were massacred and beaten back. The King tried to escape, but was captured by Productivity Land’s forces and promptly executed.

Readers can read whatever they like into the above story; it is purely fictitious, and of course massively simplified. But I think it captures the essence of the problem of  outsourcing your productivity to foreign lands who might not always be as friendly as they appear to be today.

The bottom line here is that any proposals regarding transitioning to an economy even more dependent on services assumes that goods and productivity will keep flowing into the West, even though there is no guarantee of such a thing.

Governments in the West would do better to worry about the West’s (lack of) energy and resource independence.

Sterilised QE Analysis

I write this post rather hesitantly.

From the WSJ:

Federal Reserve officials are considering a new type of bond-buying program designed to subdue worries about future inflation if they decide to take new steps to boost the economy in the months ahead.

Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates. The aim of such an approach would be to relieve anxieties that money printing could fuel inflation later, a fear widely expressed by critics of the Fed’s previous efforts to aid the recovery.

This confirms four important points that relatively few economic commentators have grasped.

First, if QE was intended — as Bernanke always said it was — solely to lower the interest rates on government debt, and force investors into “riskier” assets, rather than to directly stimulate the economy, why were the first two rounds of QE not sterilised? Is Bernanke making it up as he goes along? No — the first two rounds of QE were undoubtedly reflationary:

While the S&P slumped, the monetary base was dramatically increased. This — even as confidence remained weak — allowed the (debt-based) money supply (M2) to keep growing, and thus avoiding Bernanke’s bugbear deflationary spiral.

Second, that Bernanke— unlike Paul Krugman — is concerned about inflation expectations. Given that the money supply could theoretically still triple without any new money printing, I would be too. How might banks respond to an oil shock or some other negative supply shock? We have no real idea. Would all those reserves quickly get lent out, as more and more money chases fewer and fewer goods? We can speculate (I would say this eventuality is quite unlikely) but we just don’t know. Simply, the Fed has created a bed of inflationary dynamite, and we have no real means to predict whether or not it will be set alight, or whether the Fed would be able to temper such an explosion.

Third, that if the Fed is not willing to continue pumping money into the wider economy, the current reinflationary bubble is over. But the money supply has surged ahead of industrial production:

Without a surge in real productivity (I don’t see one coming) price levels will not be sustainable, which may force the Fed back for another round of unsterilised QE.

Fourth, the Fed seems completely and defiantly intent on driving interest rates on Treasury debt into the ground. The supposed justification — that investors are avoiding riskier (but productive) assets seems completely irrelevant. If investors do not want to put their money into equities, they will find a way not to — either by investing in commodities and futures, or in alternative monetary instruments like gold and silver. The real justification — at least for this round of QE — seems to be to cheapen the Treasury’s liabilities, especially in light of the fact that America’s biggest external creditors are getting cold feet. That takes the pressure off the Treasury, but for how long? How much leeway does the Fed have to act as a price ceiling on Treasury debt?

The hope is that the Fed will have much more leeway as a result of sterilised QE. And of course, Bernanke is hoping that there is a real economic recovery down the line so that all these emergency measures can be retired.

The trouble is that the problem in the United States was never that of too little money, but rather that of a broken economy: broken infrastructure, broken energy infrastructure, corporatism, financialisation and diminishing productivity. The Corporatocracy and their cronies in government seem to have no interest in addressing the real problems. That is fundamentally unsustainable — and no amount of QE, or demand for iThingies, NFLX, LULU or corporatist Obamacare will fix it. The real American economy is dependent on foreign goods, foreign energy, foreign components, and foreign resources and there is no guarantee that the free flow of goods and resources will be around forever. In fact, the insistence on not fixing anything — and instead of throwing money at problems — almost guarantees a future breakdown. The era of the American free lunch is over.

What we now know for sure is that the trigger for the coming breakdown is extremely unlikely to be domestic. Bernanke is a can-kicking genius, and will invent new can-kicking apparatuses as they become needed (up to the point of systemic breakdown). America must hope that he — or someone else — has a similar genius for foreign policy, and for negotiating with hostile powers upon which America has rendered herself economically dependent.

Austerity & Taxation

One of the main conclusions of — on the one hand — Austrian economics, and on the other, Modern Monetary Theory is that it is bad and dangerous for government to take more out of the economy than it puts in, i.e. running a surplus. The two schools of thought take this idea to different conclusions; Austrian economics advocates for far less government in recessions, whereas MMT advocates for greater deficit spending in recessions.

Basing my conclusions on the disastrous austerity contractions of the Bruning Chancellery, as well as contemporary Ireland and Greece, I have already railed quite strongly against the concept of austerity during a recession. Readers have (understandably) been quite sceptical. The position I am taking puts me in line with Professor Krugman, and various other Keynesian characters. And I agree that every dollar spent by the government must be taken out of the economy in taxation. And, government spending is often (but not always) plagued with problems such as regulatory capture, mismanagement and malinvestment.

But the evidence is clear — heavily indebted nations that slash spending and (as in the case of Greece today) raise taxes to “pay down debt” actually tend to experience not just greater economic contraction, but also increased deficits as tax revenues dip.

This was the American experience during the Great Depression. A great deal of attention has been given to “monetary inflexibility” (i.e. keeping the gold standard) as a “cause” of the depression, but very little attention has been given to the fact that Hoover drastically raised taxes and cut spending in 1932, just as the depression really started to bite:

The onset of the Great Depression in 1929 led to a sharp decline in tax revenues, as the economy contracted. President Herbert Hoover’s response was to push for a major tax increase. The Revenue Act of 1932 raised tax rates across the board, with the top rate rising from 25 percent to 63 percent. That increase was justified on the grounds that the budget needed to be balanced to restore business confidence. Yet the $462 million deficit of 1931 jumped to $2.7 billion by 1932 despite the tax increase. Interestingly, the major cause of the deficit’s rise was a sharp decline in income tax revenue, which fell from $1.15 billion in 1930 to $834 million in 1931, $427 million in 1932, and just $353 million in 1933.

The bottom line here is that it cuts both ways: just as cutting spending in a recession can deepen the problems, so too can raising taxes. This is because both of these things can push the nation to a position where government is sucking in more than it is pushing out. When the economy is contracting, the last thing it needs is a bigger net drain.

So the problem here is residual debt. Governments have lots of it. When leaders like Cameron, Papandreou and Merkel propose austerity, what they are actually proposing is paying down debt, much of which is held off-shore. Very often their commitments to cut are attached to a promise to raise taxes. This means that governments are committing to suck in more (sometimes much, much more) than they are paying out, which is by definition contractionary. If governments were to default on their debt, this would be a different story — governments could then maintain any kind of regime, statist or non-statist, without the problem of sucking more money out of the economy than they are disbursing. But right now — even with Iceland’s positive example — default is considered to be politically unachievable, particularly in regard to the larger states such the U.S. and the U.K.

So it is very clear that governments embarking on austerity policies are making precisely the same mistakes as the Hoover administration 80 years ago. And, of course, as revenues drop due to the punishing austerity, the situation will only get worse.

Default will become increasingly attractive for the advanced economies.

From the Economist:

Perhaps the most provocative paper comes from Jeffrey Rogers Hummel who reasons that default is virtually inevitable because a) federal tax revenue will never consistently rise much above 20% of GDP, b) politicians have little incentive to come up with the requisite expenditure cuts in time and c) monetary expansion and its accompanying inflation will no more be able to close the fiscal gap than would an excise tax on chewing gum. Most controversially, he argues that ”the long-term consequences (of default), both economic and political, could be beneficial, and the more complete the repudiation, the greater the benefits.”

Why does he take this view? Allowing for the Treasuries owned by the Fed, the trust funds and foreigners, total default could cost the US private sector about $4 trillion. In contrast, the fall in the stockmarket from 2007 to 2008 cost around $10 trillion. In compensation, however, the US taxpayer would no longer have to service the debt; their future liabilities would be lower.

After all, it has worked well so far for Iceland

The Gold Standard?

Paul Krugman doesn’t believe that the gold standard was a remedy to the ills of the Great Depression:

A while back I read Lionel Robbins’s 1934 book The Great Depression; as I pointed out, it was a Very Serious Person’s book for its era. Its solution was a return to the gold standard — which would have made things worse — and free trade, which was basically irrelevant to the problem of insufficient demand.

In fact, the gold standard is almost universally shunned (with a few notable exceptions) among academic economists. In a recent survey of academic economists, 93% disagreed or strongly disagreed with this statement:

If the US replaced its discretionary monetary policy regime with a gold standard, defining a “dollar” as a specific number of ounces of gold, the price-stability and employment outcomes would be better for the average American.

When we look at the Great Depression, we need to look at things on two levels: the causes, and the symptoms. Keynesian economists — particularly Krugman, Eichengreen, etc — are focused primarily on the symptoms, particularly depressed demand, and debt-deflation. Certainly, the gold standard is not a cure for the symptoms of an economic depression.

Trying to administer austerity after a crash like 1929 or 2008 is simply a road to more pain, and a deeper depression.

The principal attraction to the gold standard is to limit credit expansion to the productive capacity of the economy. But we know very clearly that — in spite of a gold standard — there was enough credit expansion during the 1920s for a huge bubble in stocks to form.

Ultimately — even with a gold standard — if a central bank or a government, (or in the most modern case, the shadow banking system) decide that the money supply will be drastically expanded, then limits on credit creation like the gold standard (or in the modern case, reserve requirements) will be no barrier.

The amusing thing, though is that gold — perhaps because of its history as money, perhaps because of its scarcity, and almost certainty because of its lack of counter-party risk — is as strong as ever. In a global financial system where the perception of debasement of currency is widespread, gold thrives. In an era where shareholder value is thrown under the bus in the name of CEO-remuneration, where corporations are perennially mismanaged, and where profit is too-often derived from bailouts and subsidies, gold thrives. It is a popular investment both for individual investors and for non-Western central banks.

The Federal Reserve’s monetary intransigence probably did prolong the Great Depression. Certainly there were other factors — including Hoover raising taxes.  But none of that really matters now. Certainly, it is impossible that the United States — under its current monetary regime— would ever return to the gold standard. Gold’s role has changed. It is no longer state money. It is a stateless instrument thriving in a negative real-rate environment.

And unlike state monies whose values are subject to the decisions of states, gold will always be gold.

The Decline and Fall of the American Empire

Does the hypochondriac who is ultimately diagnosed with a real, physiological illness have the right to say “I told you so”?

Well, maybe. Sometimes a “hypochondriac” might be ill all along, but those diagnosing him just did not conduct the right test, or look at the right data. Medical science and diagnostics are nothing like as advanced as we like to hope. There are still thousands of diseases and ailments which are totally unexplained. Sometimes this means a “hypochondriac” might be dead or comatose before he ever gets the chance to say “I told you so.”

Similarly, there are are many who suggest that their own nations or civilisations are in ailing decline. Some of them might be crankish hypochondriacs. But some of them might be shockingly prescient:

Is Marc Faber being a hypochondriac in saying that the entire derivatives market is headed to zero? Maybe. It depends whether his analysis is proven correct by events. I personally believe that he is more right than he is wrong: the derivatives market is deeply interconnected, and counter-party risk really does threaten to destroy a huge percentage of it.

More dangerous to health than hypochondria is what I might call hyperchondria.

This is the condition under which people are unshakeably sure that they are fine. They might sustain a severe physical injury and refuse medical treatment. They brush off any and all sensations of physical illness. They suffer from an interminable and unshakeable optimism. Government — or, at least, the public face of government — is littered with them. John McCain blustered that the economy was strong and robust — until he had to suspend his Presidential campaign to return to Washington to vote for TARP. Tim Geithner stressed there was “no chance of a downgrade” — until S&P downgraded U.S. debt. Such is politics — politicians like to exude the illusion of control. So too do economists, if they become too politically active. Ben Bernanke boasted he could stanch inflation in “15 minutes“.

So, between outsiders like Ron Paul who have consistently warned of the possibility of economic disaster, and insiders like Ben Bernanke who refuse to conceive of such a thing, where can we get an accurate portrait of the shape of Western civilisation and the state of the American empire?

Professor Alfred McCoy — writing for CBS News — paints a fascinating picture:

A soft landing for America 40 years from now?  Don’t bet on it.  The demise of the United States as the global superpower could come far more quickly than anyone imagines.  If Washington is dreaming of 2040 or 2050 as the end of the American Century, a more realistic assessment of domestic and global trends suggests that in 2025, just 15 years from now, it could all be over except for the shouting.

Despite the aura of omnipotence most empires project, a look at their history should remind us that they are fragile organisms. So delicate is their ecology of power that, when things start to go truly bad, empires regularly unravel with unholy speed: just a year for Portugal, two years for the Soviet Union, eight years for France, 11 years for the Ottomans, 17 years for Great Britain, and, in all likelihood, 22 years for the United States, counting from the crucial year 2003.

Future historians are likely to identify the Bush administration’s rash invasion of Iraq in that year as the start of America’s downfall. However, instead of the bloodshed that marked the end of so many past empires, with cities burning and civilians slaughtered, this twenty-first century imperial collapse could come relatively quietly through the invisible tendrils of economic collapse or cyberwarfare.

But have no doubt: when Washington’s global dominion finally ends, there will be painful daily reminders of what such a loss of power means for Americans in every walk of life. As a half-dozen European nations have discovered, imperial decline tends to have a remarkably demoralizing impact on a society, regularly bringing at least a generation of economic privation. As the economy cools, political temperatures rise, often sparking serious domestic unrest.

Available economic, educational, and military data indicate that, when it comes to U.S. global power, negative trends will aggregate rapidly by 2020 and are likely to reach a critical mass no later than 2030. The American Century, proclaimed so triumphantly at the start of World War II, will be tattered and fading by 2025, its eighth decade, and could be history by 2030.

Significantly, in 2008, the U.S. National Intelligence Council admitted for the first time that America’s global power was indeed on a declining trajectory. In one of its periodic futuristic reportsGlobal Trends 2025, the Council cited “the transfer of global wealth and economic powernow under way, roughly from West to East” and “without precedent in modern history,” as the primary factor in the decline of the “United States’ relative strength — even in the military realm.” Like many in Washington, however, the Council’s analysts anticipated a very long, very soft landing for American global preeminence, and harbored the hope that somehow the U.S. would long “retain unique military capabilities… to project military power globally” for decades to come.

No such luck.  Under current projections, the United States will find itself in second place behind China (already the world’s second largest economy) in economic output around 2026, and behind India by 2050. Similarly, Chinese innovation is on a trajectory toward world leadership in applied science and military technology sometime between 2020 and 2030, just as America’s current supply of brilliant scientists and engineers retires, without adequate replacement by an ill-educated younger generation.

Wrapped in imperial hubris, like Whitehall or Quai d’Orsay before it, the White House still seems to imagine that American decline will be gradual, gentle, and partial. In his State of the Union address last January, President Obama offered the reassurance that “I do not accept second place for the United States of America.” A few days later, Vice President Biden ridiculed the very idea that “we are destined to fulfill [historian Paul] Kennedy’s prophecy that we are going to be a great nation that has failed because we lost control of our economy and overextended.” Similarly, writing in the November issue of the establishment journal Foreign Affairs, neo-liberal foreign policy guru Joseph Nye waved away talk of China’s economic and military rise, dismissing “misleading metaphors of organic decline” and denying that any deterioration in U.S. global power was underway.

Frankly — given how deeply America is indebted, given that crucial American military and consumer supply chains are controlled by China, given how dependent America is on foreign oil for transport and agribusiness — I believe that the end of American primacy by 2025 is an extraordinarily optimistic estimate. The real end of American primacy may have been as early as 9/11/2001.

$29 Trillion

From the Levy Institute:

There have been a number of estimates of the total amount of funding provided by the Federal Reserve to bail out the financial system. For example, Bloomberg recently claimed that the cumulative commitment by the Fed (this includes asset purchases plus lending) was $7.77 trillion. As part of the Ford Foundation project “A Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis,” Nicola Matthews and James Felkerson have undertaken an examination of the data on the Fed’s bailout of the financial system — the most comprehensive investigation of the raw data to date. This working paper is the first in a series that will report the results of this investigation.

The extraordinary scope and magnitude of the recent financial crisis of 2007–09 required an extraordinary response by the Fed in the fulfillment of its lender-of-last-resort function. The purpose of this paper is to provide a descriptive account of the Fed’s response to the recent financial crisis. It begins with a brief summary of the methodology, then outlines the unconventional facilities and programs aimed at stabilizing the existing financial structure. The paper concludes with a summary of the scope and magnitude of the Fed’s crisis response. The bottom line: a Federal Reserve bailout commitment in excess of $29 trillion.

These bailouts saved a failed system. It allowed a broken system to stay broken, so it can break again another day. It saved broken companies, corporations and business models.

It did absolutely nothing whatever to address underlying systemic issues, like America’s oil addiction and systemic financial fragility.

Most disappointingly of all it sustained high systemic debt levels. Without liquidation of bad assets and bad debt capitalism stops working. An essential mechanism of capitalism is that new systems continually grow up to replace the old. That’s creative destruction. Without creative destruction, there is just stagnation.

In the eyes of the wider people, though, the greater trouble with these bailouts is their morality. If I leveraged all my assets, went to Vegas and lost it all playing blackjack, I wouldn’t get a bailout. That’s what the arbitrageurs of the international financial system did: they might have dressed up their addictions in the sophistry of mathematics, but the truth is it is all just gambling. Bailing out upper-echelon gamblers is just looting and pillaging the faith and credit of the world.

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).