As the old joke has it, no man's life, liberty, or property is safe when the legislature is in session. We need to amend that slightly: "No man's life, liberty, or property is safe when Keynesians control the legislature and the central bank." It's a fact — the Wall Street Journal article title welcoming back "Senate Conservatives" was a little inaccurate. They aren't conservatives. They're simply a less free-spending type of liberal. Both "liberals" and "conservatives" have it fixed in their heads that the State has a very big role in the direct running of the economy. The only question is, "How big?"
Case in point. Virtually no one other than those labeled monetary nuts wants to stop the Federal Reserve from monetizing all government debt. Many people, especially legislators, have no idea of the reason the Federal Reserve was established, or the basic theory behind it. This is very strange, for the text of the original Federal Reserve Act of 1913 is readily available, while the theory is based on the legal definition of money — and most legislators are lawyers, or (at least) profess some familiarity with the law. They certainly pass enough of them. Of course, as Cicero said, Summum ius summa injuria — More law, less justice. (De Officiis, I, 33.) Nobody pays any attention to dead, olive-skinned European males, however.
Consequently, the Federal Reserve, designed for one purpose, is used for another. This is an almost certain recipe for disaster, as has, in fact, proved to be the case. In what seems like a paradox, as the Federal Reserve is misused, the apparent need to misuse it even more increases, it might almost be geometrically. Debates at the Federal Reserve over the past couple of days were by how much — not if — the currency should be inflated and the deficit increased. While amounts as high as $1 trillion were tossed about, they finally settled on a beggarly $600 billion.
We're being sarcastic, of course. Just a little. The fact is, going by the assumptions of Keynesian economics, non-productive credit is almost worse than a narcotic. The more you spend, the more you believe you are forced to spend.
This is, incidentally, setting up the economy for the "perfect storm" of hyperinflation. Money, no matter what form it takes, whether coin, banknotes, checks, bills of exchange, or cows, is a derivative of the present value of existing and future marketable goods and services: production. As production declines and the supply of marketable goods and services dries up, the price level starts to rise, even if no new money is added to the economy. If, at the same time, new money is pumped into the economy at a tremendous rate, each unit of currency becomes worth less and less as the present value of marketable goods and services in the economy becomes spread out over a vastly increased number of currency units.
At some point, the price level starts to rise at a rate faster than the rate at which currency is being created, and the surreal phenomenon of hyperinflation takes hold. Part of this is due to the vastly increased velocity of money, but a significant portion results from the fact that the public loses complete confidence in the currency and expects prices to rise faster — so they do. The currency becomes effectively backed with nothing, so that the value of the currency is, to all intents and purposes, determined by dividing by zero, a mathematical impossibility.
The social tsunami of hyperinflation, however, pales into insignificance next to the obtuseness of the powers-that-be that continue to insist, all evidence to the contrary, that the current situation is the only possible situation, and that there is nothing that can be done about it — aside from spending more money.
So — what do they think is going to be the result of this latest stimulus?
According to Keynesian theory, an infusion of money into the economy will raise the price level. This will force wage earners to cut consumption, generating the savings necessary to finance new capital investment and create jobs. There are two things to keep in mind in the Keynesian framework. One, the definition of savings is always cuts in consumption — always. Two, the only source of income for "the masses," and thus production, is human labor, as the Keynesian productivity equation of output per labor hour demonstrates.
Consequently, wage earners are forced to cut consumption by paying more for the same amount of goods and services or the same amount for fewer goods and services. This is Keynesian "forced savings," not to be confused with Kelsonian "future savings." Keynesian forced savings robs the poor for the benefit of the rich, while Kelsonian future savings has the capacity to benefit the poor without taking anything from the rich.
So (in Keynesian theory) inflating the currency provides producers with "savings" that they can then use to finance new capital formation to make money for themselves and create jobs for the rest of us. Job creation increases effective demand, presumably making up for the decreased consumption caused by inflation.
Two more things to keep in mind about this Keynesian scenario. One, even Keynes admitted that individual wage earners are never as well off after inflation as they were before. It's in the aggregate that people are better off because of the job creation that presumably takes place. This is one of the reasons that Friedrich von Hayek criticized Keynes for Keynes's implicit collectivism. (Which causes one to wonder how von Hayek missed explicit totalitarianism in the first couple of pages of Keynes's Treatise on Money.)
Two, this Keynesian scenario not only isn't working, it can't work. Frankly, Keynes didn't understand the language of business. Elementary bookkeeping was a sealéd book to him. Trying to put it as simply as possible, the primary use for savings in a corporation is not to finance new capital. Very little if any new capital is financed directly out of savings — "retained earnings." New capital is financed by taking cash — an asset, not savings — and trading it for another asset, or (far more common), taking out a loan and offsetting the increase in assets with an increase in liabilities.
In neither case is retained earnings (savings) touched. The only charge against retained earnings is dividends, not expenditures for new capital. Retained earnings usually serve as collateral for debt financing of new capital, not as financing directly. Even when retained earnings are paid out as dividends and used to finance new capital formation when the recipient reinvests the money, it is not to the advantage of the company that paid the dividends, but to the company in which the recipient reinvests the money.
Nevertheless, corporations tend to make greater and greater profits in times of inflation. Even during the hyperinflation in Germany it was noted that the few producers were able to make enormous fortunes, usually by selling their goods and services at as high a price as possible in the inflated Reichmarks and immediately converting the profits to foreign exchange. This was another factor in fueling the hyperinflation, as producers tried to raise their prices as fast as they could, regardless of the rate at which new money was being created, in order to increase profits — and thus savings — as rapidly as possible.
The difference between the United States in 2010 and Germany in 1923 — or even the United States in 1929 — is that the Germans of 1923 and the Americans of 1929 were, at the same time they were speculating in currency and secondary equity, respectively, also financing new capital formation. While this puzzled commentators at the time, Dr. Harold Moulton's analysis was that the commercial banks were creating money for new capital investment at the same time that they were creating money for speculation. This is an impossibility within the past savings assumption of Keynesian, Monetarist, and Austrian economics.
Unfortunately, American companies are not financing new capital formation with this windfall. Instead, they have accumulated record amounts of cash — approximately $1 trillion according to news reports. This is not being used to distribute dividends and increase effective demand, or to finance new capital and create jobs, also creating effective demand, but to buy back their own shares. This not only concentrates ownership of the means of production even more than now, it also drives up the prices on Wall Street.
The Federal Reserve now proposes to make up for the failure of corporations to use their accumulations to finance new capital by pumping another $600 billion into the economy by purchasing Treasury paper. Whether this is through "open market" operations by means of which the Treasury funnels debt to the central bank through "brokers" whose only function is to turn primary issuances into secondary in a microsecond, or by purchasing bonds from existing holders, the effect will be the same. Corporations will accumulate even more profits, or existing holders will accumulate cash, all of which will be poured into the stock market, which right now appears to be the only place where money can be made.
More problems. One, the stock market is a secondary market. None of the money poured into Wall Street finances one cent of new capital. Two, the rise in the stock market is purely speculative. Current production and projected future production and consumption of marketable goods and services do not support the rapid price rise. Even under the limited and limiting labor-oriented assumption of Keynesian economics, the combination of a rapidly rising price level anywhere (but especially on Wall Street) and high unemployment is a very, very, very dangerous sign. If people aren't earning, they aren't spending. If they aren't spending, there is no incentive to produce. If producers aren't producing, and consumers aren't consuming . . . well, where is the economy? What economy?
The academics and politicians can take great comfort in the fact that the stock market keeps rising. Similarly, some academics were convinced that the hyperinflation in Germany between 1919 and 1923 wasn't really happening because, clearly, some people were making huge fortunes. In 1929, even Irving Fisher, according to Milton Friedman "the greatest economist America has ever produced," was convinced that the stock market would keep on going up forever. (Yale University had to bail him out to the tune of millions.) It's entirely possible that the Dow will go up to 15,000 or more within a very short time — there is, after all, a potential $1.6 trillion being poured into secondary issues. The problem is that, without new capital investment and an increase in effective consumer demand, the prices on Wall Street cannot be sustained. Nor will increases in consumer debt solve anything, as it must either be repaid (cutting future consumption) or forgiven (reducing profits and thus savings presumably necessary to finance new capital).
It seems hopeless, yet the solution is not only obvious, it is simple — though not easy. It's hard to break an addiction, especially when the addict refuses to admit there is a problem. Absent a genuine will to reform, or the belief that reform is possible, rehab only trains the addict to adopt increasingly cunning methods of maintaining him- or herself until the next crash.
As we've pointed out countless times on this blog (okay, maybe not countless . . . the number of postings to date is less than 700, so the number of times we've pointed something out must also be less than 700 . . . although you'd think somebody would start paying attention after more than 600 iterations of the same basic point.
Or not. Maybe it will do some good to say it one more time: Capital Homesteading by 2012.
If nothing else, it beats blaming everybody else on the face of the earth for one's problems.