In the late 1970s, after years of stagflation, I concluded that Keynesian economics didn’t work. The politicians would rarely muster the courage to retrench government spending in times of prosperity; as was mandated by the theory. In 2009, in the aftermath of the Financial Panic of 2008, Alan Greenspan gave testimony before congress concerning his loose monetary policy that contributed to the housing boom and bust that led to the Panic. After the tech bust in 2000/1 and the Twin Towers attack, the Fed contrived the lowering of interest rates to cushion the economic impact. However, Greenspan admitted that he was averse to restoring interest rates to historical norms in 2003, lest the U.S. unemployment spike to 10%. Upon hearing that testimony, I concluded that Monetarism wasn’t much of a panacea either. Non-elected bureaucrats have no greater courage than the politicians. It is not necessarily that the models are wrong. It is that good economics must take the human element into account.
The purposes of Keynesian and monetarist policy is to moderate the peaks and valleys within each business cycle. Practiced with fidelity, they ought to be, in of themselves, a sum-zero game after each cycle. However, like derivatives, the uses of that policy have dangerously proliferated well past those original intents. These policies are now seen as sources of economic growth. To give an example; the latest Quantitative Easing (QE3) on September 12, 2012, had stated intents of “to generate sustained improvement in labour market conditions”1.
Once, one surveys beyond the dazzle of econometric statistical wizardry, the essence of these expansionist policies is the invitation and incursion of indebtedness; with Keynesian policies, government (public) debt; with Monetarist policies, private debt. And by these debt-inducing stimulants, it is believed that a moribund economy could be jolted awake; and perhaps, with all its multiplier effects, pay for itself. If the motivation is the former, then the economic theory is based on psychological “feel-goodism”. If the latter, then why hasn’t any other nation thought of just stamping coinage, printing money or granting currency credits out of thin air, into perpetual prosperity? Oh they have! The Romans debased the silver content of the denarius to 2% and a collapse of the currency and economy occurred in 268 A.D. (barter system temporarily replaced it). I met a Swede in my travels in 1978/9, who told me that his grandfather used to come over to Weimar Germany to purchase paper fiat for firewood.
(For, pedagogic purposes; monetary expansion by the Fed occurs when existing debt instruments that exist at banks are swapped out for currency. (It would seem that the credit risks will now be assumed by the Fed, enabling the banks to report a profit as funds that were set aside for such defaults are pocketed. However, I am not to sure about this.) Those new funds ought to promote new loans; since normally, idle funds in a bank lose real value with any form of inflation or in terms of opportunity cost etc. In other words, the Fed is promoting increased indebtedness.)
This produces a ‘false economy’. For, this debt must eventually be repaid. And when deleveraging (paying back of debt) occurs, that same multiplier effect will accelerate the dampening/depressing effect on the economy. In many ways, that is exactly what has happened in these last 4-5 years. However, the governments/central bankers have tendency, for sociopolitical reasons, to attempt to counter this normal state of affairs through fresh incursions of debt inducements. It becomes an addiction, which ends when a credit or deficit/debt ceiling is reached, as it surely must. At that stretched point, the state incurs a debt-deflationary spiral, which no amount of state intervention will be able to forestall, short of draconian and autocratic measures.
This has, in varying degrees, been occurring in the U.S. since the mid-1990s. Although I didn’t cop on at the time; there was a relationship between Alan Greenspan’s phrase ‘Irrational Exuberance’ in a December 1996 speech to the American Enterprise Institute and his very loose monetary policies. The loose monetary policy has largely not abated in the interim years since. At the time, Greenspan claimed that he could push interest rates lower in order to reduce the joblessness rate because international competition was keeping wage rates and pricing subdued. In that, he succeeded. The NAIRU rate, the lowest perceived unemployment rate at which it is believed that inflation rears it ugly head, was challenged. Prior to that point, the NAIRU was believed to be 6%. However, unemployment rates were brought down to as little as 4%.
However, the problem with the analysis is the overconfidence in the sufficiency of government inflation measures to indicate to the real state of inflation. Consumer Price Indicators (CPI) and similar barometers measure and take into account living expenses of the average consumer. Of that, assets, such as homes, carry little weight in its composition.
However, because of a myriad of factors; wage pressures, which often hold the largest sway on price inflation; was weakened. The sociopolitical climate constituted one such factor. The conservative reaction since the 1980s, against the excesses of unionism and inflation-inducing policies of the prior decade, weakened public support for labour. The collapse of the Soviet Union and the credibility in socialism everywhere reduced self-interested concerns about a home-grown threat of socialist sentiment. Certainly, productivity gains from the computer / Internet revolution were starting to finally manifest themselves by the late 1990s. However, it was in free-trade globalism that domestic wages were in perpetual threat to offshore offsourcing that allowed for minimal apparent inflationary effect of otherwise inflationary policies.
In Adam Smith’s “The Wealth of Nations” (1776), he suggests that prices of any commodity, including labour, are a function of supply and demand. Such a description can be recast as a power relationship. That is, when existing laborers must contend with an army of unemployed or other available labour resources, the bargaining leverage that these existing labourers have has diminished. Open up the borders to the floodgates of low-wage labourers, reduce the skillset required to perform the same tasks, and the organic economic power between corporations and labour becomes extremely tilted in favour of the former. Therefore, the proceeds of all productivity gains and new wealth flow largely if not totally, as has been the case in these last two decades, to the upper echelons of society.
Is there empirical proof to the charge? Because I was in I.T. until very recently; I was fortunate to benefit from the I.T. boom of the 1990s and early 2000s. My own wage / consultant rates rose much faster than compatriots in other fields; earning as an uncredentialed network admin staff more than credentialed engineers at one point. I found that the only other beneficiaries of higher than inflation rate of corporate wage advances on year-by-year basis were the highest management. The wages for the type of job I did has declined approximately 25% in absolute terms since that peak in 1999. The inordinate wage hikes for upper management never stopped. The CEO to median wage earner rate rose from 40x (1960s and 1970s) to wild swings above and below 300x in the last decade. I come across many skilled and experienced labourers, whose training gave them 10 – 15 years of credible wages before the jobs, they trained for, were lost to 2nd and 3rd world competitors. I have an acquaintance who subcontracted his programming project through an American agent who received $13/hour and probably paid the East European contact about half of that. The stories and artifacts can abound. However, the raging income and wealth disparity is not the subject of discourse today.
The Forbes Price Index Of Luxury Goods has risen to little less than 9.5x the 1976 price level. The U.S. CPI rise is about 4x. Fairly strong and accelerating inflation has been occurring for the well-to-do, particularly in the last decade. This gives evidence that the surplus of new wealth that is being distributed to the wealthier set is outpacing the supply of preferred goods available for them to purchase. It would also correspond with price spikes in asset values in comparison to rises in everyday living expenses for the average consumer. Assets are the favored purchases by the upper echelons with their new sources of wealth. And we have seen evidence of this inflationary spiral in overall asset values bulging into periodic bubbles and busts in different asset classes; tech stocks, derivatives, housing, gold, commodities and bonds over the last two decades. Some of the latter classes have yet to complete their bust cycles. A bond bust would probably be the mother of all busts.
To give general price level inflation indexes inordinate consideration in setting monetary policy demonstrates lack of full comprehension of all inflation threats. Much of the extra cash does not appear to be going into productive investment but into the purchases of existing assets in one speculative frenzy after another. If normal demand (without incurring extra indebtedness) is not rising because wage rates of consumers are stuck in stagnation, it is not a particularly good market to invest in normal goods and services production. Or if all the proceeds from productivity gains are going toward only one sector of the economy, which is having difficulty finding goods to purchase with the new found wealth, one lacks a consumer for the increased supply of goods and services. Monetary funds may be far outstripping worthwhile ideas and innovations to exploit. So when the banks do lend out; rather than play it safe with maintaining higher reserves in their vaults, so to speak; it is largely going to sustain spiraling asset bubbles.
The problem with asset inflation is the corresponding asset deflation; especially with borrowed funds. It can lead to the Debt-Deflationary cycle of the Great Depression that Fischer in the 1930s describes. And the U.S. government agencies, whether through Federal Government policy of surreal deficit spending or through central banker policy of reducing interest rates as low as they can pretty much go; have left no cushion room to mitigate against a Debt-Deflationary cycle without causing a credit or currency crisis in the U.S.
The problem lies in utilizing only a truncated set of indicators to measure inflation.
Footnotes:
- Board of Governors of the Federal Reserve System, “Press Release”, September 13, 2012, http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm
An Iconoclastic Orthodoxy 