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The Easy Money Enablers

Structural reform is needed – but those in charge have no incentive to deliver...

ALONGSIDE the clamor for more monetary monkey business, much lip service is also being paid to the need for 'structural reform', writes Sean Corrigan for the Cobden Centre.

In the Austrian sense of increasing responsiveness and removing barriers to initiative – what Fritz Machlup called an 'Auflockerung' – this is indeed a necessity. But this is not something which will be enacted by governments eager to extend corporate welfare to failed Wall St. Banks, uncompetitive French car companies, needlessly duplicated Chinese steel manufacturers and the like. 

Nor are they and their central banking friends likely to aid the requisite process of 'recalculation' – of working out what one should pay for something today and what one is likely to get for it or the things fashioned from it, tomorrow if interest rates are being falsified, taxation is volatile (upwards, at least), and exchange rates are subject to sudden wrenching shifts.

At bottom, to be coherent, interest rates should correspond to the price ratio between present and future goods and the eagle-eyed entrepreneur is the man who can recognize an arbitrageable disparity between the two in specific instances and hence can put something which is currently being undervalued to a better, alternative use. But, if he judges the spread between current inputs and his expected, risk-adjusted output is too narrow to be worth his effort, he will not be willing to provide an income to those selling the first, or employment to those who might otherwise make a living by transforming them under his guidance into the second.

Yet much of the thrust of today's rabid Rooseveltianism is conspiring to keep this critical spread overly compressed and entrepreneurs understandably coy to embark upon major new undertakings.

  • Raw inputs cost too much because of easy money, ZIRP storage arbitrage, green rent-seeking, and welfare-subsidized consumption
  • Labor remains expensive due to dole-encouraged withholding and the high ancillary costs imposed by an overweening and unaffordable state apparatus
  • Expected returns on capital – outside of those to be gained by gaming the capital markets, that is – are depressed by the anti-capitalist thrust of taxation and the regulatory and legal flux to  which entrepreneurs are being subjected to an unnecessarily elevated degree
  • The prospective flow of sales receipts is also being diluted by the presence of so much state- and bank-supported, sub-marginal deadwood in the market.

One of the features of a slump in which can be found the seeds of a subsequent regeneration is that the inputs to a more sustainable and inherently profitable production process can be had cheaply. To this end the irrational fear of the bogeyman of 'deflation' is itself the root cause of the process by which the aptitude for change and the appetite for risk can become quasi-permanently suppressed.

Bankruptcy breaks up unviable capital combinations and frees up willing workers for the business of founding new industries and of identifying and satisfying new tastes, a point that Ludwig Lachmann was every ready to extol. 'Capital' is a concept; it is a dynamic, it is not an inert, physical lump of easily-stilled mechanisms. In the right hands, yesterday's failed crop can become the fertilizer of tomorrow's harvest as long as its owners are encouraged to realize their losses and to sell it on to those with a better vision of how to utilize it at a price commensurate with the new endeavor's chances of success.

Sadly beguiled by their own theoretical cleverness, those setting policy today are so fixated on the idea of forcing people to buy things just to be rid of the excess money which is being forced upon them and so dead set against anything actually costing less than it used to, no matter how ludicrous the previous valuation or how commercially wrong-headed the purpose to which it was being dedicated, that their own efforts at 'stimulus' are forestalling this act of revaluation and release – this recapitalization of the decapitalized – and so are turning them instead into the greatest mass sedative ever prescribed to the mercantile classes.

In our Austrian narrative of a 'cyclical' inflation, fiduciary (unsaved) credit is preferentially funneled towards investment in new capacity and expanded business. This soon leads to an unlooked-for degree of competition for resources with the earners of increased wages who are mostly still unsated in their demand for the existing array of consumables, items which the expansionists are either not planning to provide just yet, if at all. Such a conflict of desire can only end up in widespread over-extension; in the appearance of large quantities of 'frozen' capital; and hence in disappointed creditors and investors amid a general disco-ordination of plans.

In contrast to such an overheated condition, much of today's unsaved credit is being directed at ensuring that zombie companies can display the barest signs of animation so as to enable their bankers to justify the 'evergreening' of their loans. Working on a cash basis, possibly too unprofitable to pay tax, certainly not amortizing their debt and probably bleeding capital by eating into their depreciation allowances, such ICU-institutions do little more than clutter up their lenders' balance sheets, cling on to experienced and diligent staff, occupy prime property, burn electricity, and buy in stock – and so deny their more vibrant, self-reliant counterparts, whose innate abilities are greater but who have to operate on a fully commercial basis, the room and the means to grow.

Every great efflorescence of life, every great evolutionary advance in the long and violent history of dear old Mother Earth has come in the wake of a mass extinction. Without the Alvarez meteorite, after all, we hairless apes would probably not be here to debate the finer points of how our policies are only serving to maintain the economic dinosaurs in command of their niche, far beyond their natural span.

Making matters worse, the remainder of the credit inflation is being monopolized by incontinent states and their skulk of rent-seeking jackals, elites whose intrinsic capital efficiencies are vanishingly small (if not actually negative) and whose activities are therefore particularly likely to contribute to capital consumption.

Here we are faced with the awful irony that, in their manful attempt to lighten the load of indebtedness, central banks are helping generate ever more debt. Whereas the money they are creating is supposed to be a final means of settlement which extinguishes debt at the completion of a contracted period of service, it is instead giving rise to more of that which must, one day, be settled. Hence the source of that widely-shared and intensely pernicious confusion of what are static accounting identities in the macro reports with the dynamic process of economic life. 

We do not need someone else to borrow in our place if we choose to pay down our debts: if we sell without buying in order to discharge our obligations, our satisfied creditor now has both the wherewithal and the available wares to buy in our stead. Even if we find, alas, that we cannot fulfil our contract, to substitute another claim for it by transferring it to some larger, less constrained entity such as the state is to fall for a sunk cost fallacy. We took and used the present goods over which command was given us by our lender and we turned out not to be able to replace them: thus they are irrevocably lost, no matter what anyone cares to scribble in the pages of their accounting ledger.

Unable as we are to see this, we will continue to invest in negative productivity and purposely to select against the fittest. Instead of a classic Austrian overheating, we now have an Ice Age: instead of a credit bubble, we have a debt black hole.

Just as in Japan, we have transferred private actor difficulties into public sector ones where no legal framework exists to resolve the resulting problems. Worse than this, we now face a classic 'public choice' trap, to introduce the concept elucidated by the late, great James Buchanan.

Once we decide to move private liabilities onto the public balance sheet instead of swiftly excising them in the crisis, not only are the protocols for later resolution sorely lacking, but the incentives are almost entirely absent, too.  Being 'public' debts which no individual entity can be said to have incurred, there is too diffuse a sense of responsibility for them – if not an outright tragedy of the commons. Since there are no identifiable culprits for the evils they entrain, outside the hated 'capitalist' caricatures of popular invective, it is all too easy for the economic illiterates in parliament to pretend that they were in no way responsible for the debt the incoming regime has inherited (even if often in great part from its own former time in office).

Wedded to the state's arbitrary ability to impose financing charges on third parties (and the fact that pressure-group politics will see the regime's court favorites and swing voters militate not to bear any concentration of this cost) is the fact it runs completely counter to political ambition to say "we will do less - less intervention, less spending, less feather-bedding – than the losers you just ejected".

Given a further boost by the almost universal faith in half-digested Keynesian nostrums (exemplified perhaps by the recent apotheosis of the dreadful old Leftie patriarch, Robert Skidelsky), we are about to discover that by saving the banks, we are destroying the pension and insurance companies upon whom the average man is no less reliant. As a result, many of our present day states are fast approaching the limits of budget credibility and so have no choice but to resort more and more to seigniorage in order to survive. Some would, indeed, already have exhausted that reservoir, too, were it not that such infernal devices as TARGET2 allow them to draw heavily upon the reputation and good-standing of their neighbors.

That this policy has not yet led to a resurgence of  old-fashioned, shopping-basket price rises (even if, in contrast, its malign, if seductive, effect on asset prices is not to be denied) is largely down to luck.

An increase in the supply of money leads to higher prices only to the extent its recipients' desire to hold it does not increase in due proportion. What we have seen in the past four years is that, largely, it has. Firstly, higher degrees of credit have lost much of their superficial sheen of 'moneyness' since the collapse, meaning that the parties to an exchange are now far less willing to rely upon the ready negotiability and unquestioned fungibility of lesser IOUs as a means of settlement than they were during the boom. Secondly, the banks themselves have not been able to throw off so many of their more dubious accommodations into the ask-no-questions-tell-no-lies underworld of a now-moribund ABS market. Adding to the squeeze, as we have already set out, they have encumbered their balance sheets with a host of low-grade borrowers at the same time that both regulatory capital requirements and wholesale market funding possibilities have become a good deal less conducive to blind expansion than they were in the Blue Sky days of yore. Thus, a greater proportion of a money supply which is having to 'do more work' than has been the norm is being generated 'outside' the commercial banks rather than 'inside' them – i.e., by the central banks through their vastly expanded range of operations.

This, too, is a case of lowest common denominator lending, since what these central banks prefer to monetize above all is government (and quasi-government) debt. In this way they are temporarily satisfying people's heightened need for money by removing the worst constraints from those closet Jacobins who, we have argued above, are the very people obstructing the process of recuperation and regeneration.

With a nod to the ideas of Axel Leijonhufvud, what this also may imply is that the income-constrained recipients of welfare (personal or corporate) are the agents least likely to cling on to any of their dole, while the still-healthy who receive it at one remove are fast becoming Ricardian equivalence hoarders – knowing, as they do, that, as the only obviously identifiable sources of wealth and with very little patronage to shield them, Leviathan will soon come ravening after them. So, with the associated opportunity costs eradicated by the central banks' flawed attempts at stimulus, they are clutching tight to their caches of sterile silver ahead of the day when they fear they must render it up wholesale to an aggressively insistent Caesar.

Thus we have the paradox that, on the one hand, we must be grateful that the central banks are finding too few takers for the snake oil of inflation to do its corrosive work because the supposed solution it offers is not only arbitrary and dishonest, but because it also confounds accounting and so destroys capital and wastes further resources – progressively the more so, the more rapid and variable its rate of propagation. That it also tends to favor the least savory elements of society (i.e., the plutocrats and the politically-protected), means that any stay of execution is further to be welcomed on moral, as well as on material, grounds.

On the other hand, the maintenance of ZIRP – and its extension across the maturity spectrum is doing little to help and much to harm. Some say it counter-intuitively promotes saving as those who still can set more current income aside to make up for the lowered returns they receive on their nest eggs. If only this were so, for even though this is something the mainstream perversely insists on decrying, it is actually the wellspring of our well-being. Your author, however, doubts it does much to promote saving in any productive sense: instead it serves to keep capital locked up in dead undertakings and so slowly bleeds the rest of us dry, therefore destroying real savings, not adding to them and continuing the recession, not curtailing it.

At some point, this dangerous impasse will have to be resolved, either in an admission that macroeconomic means have failed and that renaissance must at last be sought – as we have long argued – in providing a more conducive microeconomic milieu (an epiphany which will be a long time coming since it implies the headlong retreat of the Provider State militant) or, alas, in a 'flight to real values' and a conflagration of financial claims to wealth amid the rubble of a monetary collapse.

But perhaps we must not be too hasty in calling for the turning point to arrive. Japanese experience teaches us that the stand-off can be maintained for nigh-on a generation if the benefits of slow price declines (not 'deflation', please) become widely recognized and if people further accept that if the state is to subsume their unserviceable private debt contracts while not taxing the skin from their backs in order to do so, they must volunteer to surrender up a good part of their income to it by continually adding to their holdings of its obligations (both dated – JGBs – and perpetual – currency). Of course, it helps if the people in question are both productive and thrifty enough to have no need for external finance and possess a high home-bias in their investments and so are not overly susceptible to sudden reversals of sentiment on the part of the hot-money crowd.

As for the rest of us – who are not necessarily endowed with such commendable attributes of forbearance – whether we further resist it or no, everything points to the conclusion that the Mighty Ozzes at the central banks have not yet lost their will for the struggle and that the creeping 'euthanasia of the rentier' and 'monetary policy à outrance' will be further prosecuted, no matter how high the cost or how exiguous the results.

Such is the curse of the Platonic arrogance of our masters and their willing enablers.

Time to Buy Gold?...

Stalwart economist of the anti-government Austrian school, Sean Corrigan has been thumbing his nose at the crowd ever since he sold Sterling for a profit as the ERM collapsed in autumn 1992. Former City correspondent for The Daily Reckoning, a frequent contributor to the widely-respected Ludwig von Mises and Cobden Centre websites, and a regular guest on CNBC, Mr.Corrigan is a consultant at Hinde Capital, writing their Macro Letter.

See the full archive of Sean Corrigan articles.

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