Monday, August 13, 2012

The Coming Crash

A short time ago someone referred us to a video about the upcoming financial crash (which, truth to tell, we rather expect ourselves unless Capital Homesteading is adopted soon). The problem is that there was just enough truth in the video to be misleading. Two things in particular undermined the credibility of the presentation:

1. They used the wrong definition of money. Kelso described it very well in Two-Factor Theory as a mere symbol, but it can be summarized even better by giving the legal and accounting definition: anything that can be accepted in settlement of a debt. The video commentators were using the standard Keynesian-Monetarist-Austrian understanding, which is 180 degrees from Kelso.

2. They were correct that in 1929 the private sector was creating money at a tremendous rate for speculation, and at a lesser, but still rapid rate for investment in new capital formation, while today the government is creating money at an even more tremendous rate for non-productive spending. The commentators made no distinction between good uses of credit, and bad uses of credit, however. They made it sound as if all credit is bad, per se, and all that is needed is to stimulate consumption.

The main difference between 1929 and the situation today is that money creation for both productive and non-productive purposes was going hand-in-hand. In the productive sector of the economy, this resulted in a temporary over-capacity, just as it had in 1873 and 1893. Had ownership of the new capital been widespread as Kelso advocated, there would have been no problem, as the expansion of productive capacity and the ability to consume would have grown at the same rate, and the Panics of 1873 and 1893 would likely never have happened, and the video's concern about the drop in consumption from 50 to death would not even be an issue.

Today, however, there is no expansion of productive capacity; demand is drying up as people lose their jobs and do not replace labor income with capital income. Instead, what demand there is comes from inflationary government spending and private sector money creation through expansion of consumer credit.

In 1929 after the Crash, banks stopped lending because the equity shares many businesses were using as collateral, and the market value of the businesses themselves (and thus their creditworthiness) had declined drastically. Again, Kelso's idea of capital credit insurance to replace traditional collateral would have prevented the slowdown in lending that led to the (second) Great Depression. Had not bank lending declined, there would have been no Great Depression simply because there was no other connection between the productive sector and the secondary market for equity.

Today's situation is more akin to what precipitated the Panic of 1825 than the Crash of 1929. In 1825 there was widespread speculation (they called it "investment," of course) in what is today known as "sovereign debt." As a result of new theories of money and credit and national sovereignty, private sector money (bills of exchange) was no longer considered money, only gold, silver, and government-emitted bills of credit. The money supply had become disconnected from the productive sector.

The new republics in Central and South America, including one fictional country, the "Republic of Poyais" ("The greatest fraud in history"), floated large amounts of sovereign debt to get their governments up and running. Since these debt issues were backed by tax bases that no longer existed in most cases, the crash was probably inevitable, and the Panic of 1825 is considered the start of the modern business cycle.

From a Kelsonian perspective, of course, there is no reason there should even be a "business cycle"; it is the result of separating money creation from production and allowing governments to monetize their deficits. The so-called Keynesian counter-cyclical approach is thus a contrived solution to an artificial (man-made) problem, and has the effect of pouring gasoline on the fire.


No comments: