Monday, 5 January 2015

Welcome to A Very Dislocated 2015

The economy is pushed forward through people working, investing, spending and saving. For an economy to progress saving is key as without it there would be no spare resources set aside that can be channeled towards investments. And without investments, there can be no economic progress. 

There are however economic pundits who claim that a "shortage" of money is the real economic problem to be solved, and not a lack of saving. There can be few doubts that the Federal Reserve belongs in that particular camp championing easy money. Following six years of more or less endless money printing, the Fed managed to keep the money supply growth at a high level while at the same time putting its owners, the U.S. banks, in the current position where they are literally swimming in cash (cash currently makes up about 18.3% of U.S. commercial banks' total assets having averaged just north of 5.7% for the 1985 to 10 September 2008 period). As the Fed has done next to nothing to raise reserve requirements, most of these bank cash holdings are classified as excess reserves. And excess reserves are what make banks able to create ever more money. 

Creating ever more money does not solve anything however. More paper and electronic money is not a resource making humanity better off. In fact, the defining property of the fiat money in existence today, and a property distinguishing it from other goods, is that a greater abundance provides absolutely zero benefit upon society. The U.S. is no better off if it has $10 trillion in money supply instead of just $1 trillion. In all likelihood, it is worse of instead. Why? Because an expanding money supply distorts prices in the market place and pushes interest rates artificially low. In addition, an expanding money supply facilitates increased government spending above and beyond that which tax payers would be willing to pay through taxes. Zapping of means results as labour and natural resources are committed to projects and permanent spending programs that could not have been undertaken without an expanding money supply. Someone has to pay for it all and this can only make people worse off in economic terms than they otherwise would have been. 

As we enter another new year, we are one step closer to witnessing the end game of some of the many economic distortions created by the U.S. monetary "policy". Some of these dislocations are only too apparent to mention: the stock market bubble, the treasury bond bubble, rocketing house prices in certain areas, government spending, education. The list goes on and is likely as thick as a dictionary. Some of these bubbles simply could not have reached the current levels absent an inflating money supply. Instead of having an economy built on labour efforts, investment, spending and saving, the U.S. has increasingly substituted these with an ever expanding money supply... 


...and stagnating saving...


...leading to the money supply growth vastly outpacing that of saving. 


As the CPI and PPI remain relatively low (to the extent we can trust these difficult to calculate numbers) and as private investment is also running at a relatively low level given the vast expansion in the money supply, it does not take a whole lot of imagination to conclude what a sizeable proportion of the money is being spent on in addition to government programs: financial investments and speculation. Welcome to a very dislocated 2015 not only for U.S. citizens, but for the many countries around the world that have chosen a similar path from riches to rags. 

Fiat money inflation and cheap loans to the government convey additional funds to the treasury; deflation depletes the treasury's vaults. Credit expansion is a boon for the banks, contraction is a forfeiture. There is a temptation in inflation and expansion and a repellent in deflation and contraction.  
But the dissimilarity between the two opposite modes of money and credit manipulation not only consists in the fact that while one of them is popular the other is universally loathed. Deflation and contraction are less likely to spread havoc than inflation and expansion not merely because they are only rarely resorted to. They are less disastrous also on account of their inherent effects. Expansion squanders scarce factors of production by malinvestment and overconsumption. If it once comes to an end, a tedious process of recovery is needed in order to wipe out the impoverishment it has left behind. But contraction produces neither malinvestment nor overconsumption.
Ludwig von Mises, Human Action