Keynes's Blind Spot: Consumption is Production Shared

Bret Stephens has written a nice opinion piece in the Wall Street Journal of December 23. He cites poet Rudyard Kipling and author George Melloan who wrote The Great Money Binge: Spending Our Way to Socialism.

Melloan's work, according to Stephens, shows "in exacting detail, not only how we came to our current crisis--thank you, Barney Frank, Chris Dodd, Alan Greenspan and Tom DeLay--but where [their flawed logic] is destined to take us again."

All four of these politicians--yes, Greenspan is one of them--seem to subscribe to Keynes's theory of what some have called "demand-side economics." This theory says that consumption is the answer to an economic bust cycle, and that it's okay to create the credit to pay for it through central-bank-created funny-money.

Stephens, citing Melloan I presume, and parodying Kipling, counters Keynes's theory using the supply-siders' argument:

"'[C]onsumption must be paid for with production" ... if you don't work (i.e. produce) you die (i.e., can't consume)."


[Thanks to Allposters.com for this image.]

Stephens and Melloan have understood the evils of Keynesian spending-for-prosperity, to be sure; but they have missed an essential point, which is this:

Consumption is purely a mechanism by which producers share among each other what they have already produced.

(See this post and the subsequent two posts for a more detailed example of this process.)

You see, production and consumption are two sides of the same coin, and production always comes first. One is given life by the other. Consumption cannot exist without production. We divide our production among ourselves on a global basis through the exchange among ourselves of small or large portions of what each of us has produced; and this action is called consumption.

We have gotten a distorted picture of this process, because often we see something we want and we think we have to work to procure the money to buy it. However, in reality the production of that thing came first, and the producers of that thing took their share of the product they produced by accepting a sort of warehouse receipt we have collectively come to label "money" instead of the produced thing itself. When we go to work, we simply become part of the exchanging group, much as a poker player buys chips to participate in the game.

Keynes obviously did not agree with this idea. He wrote as though he believed money has become a tool to be manipulated by politicians and their academic agents, as though it were a vague exchange medium representing nothing more than grease facilitating the performance of our monetary machine.

Like most people, Keynes also confused money (actual warehouse receipts, representing a share of production) with credit (a promise to repay a certain amount of warehouse receipts). Credit is not the warehouse receipt itself, but rather an expectation to receive warehouse receipt(s) within a specific timeframe, based upon the lender's faith that the creditor will hand over warehouse receipts in the short-term, when he or she has actually produced something and receives warehouse receipts as payment (or sells something he or she already owns).

Problems arise when credit promises are not fulfilled. For example, banks sometimes issue credit to market participants over and above producers' capacity to sell. Our current monetary system actually encourages banks to do so to an excessive degree, for reasons that I have treated elsewhere. (See this article, Page 1, Page 2, Page 3, for example.)

It is normal that at some point in every business cycle, banks will become overconfident and begin over-expanding credit by making bad loans. As a result, producers will manufacture (and sellers will purchase, stock, and try to sell) excess production. Under a healthy banking system, slower sales cause sellers' inventories to rise. As a result, they stop ordering, producers stop producing, and things return to their original equilibrium.

However, in an imbalanced banking system, credit starts to circulate, which means that buyers keep buying, profits keep rising, and sellers keep selling at higher and higher prices (too much money chasing too few goods). Producers receive increasing orders and on that basis get even more credit from the bank. They hire more workers, creating a misallocation of labor.

Then, with profits rising inordinately, a speculator instinct wakes up inside some otherwise normal businesspeople. These market players realize that instead of working, they can make lots of easy money borrowing credit, gambling on the stock market, betting on derivatives, playing the foreign-exchange gambit, or flipping real estate, i.e. making fast profits producing nothing.

Bad credit begets bad credit in an ever-climbing spiral. The boom game has begun, misallocating huge sums of what appears to be real money (warehouse receipts), but which in fact is only bad credit.

Then one of the sectors hits a snag. Very often it starts in the financial sphere when someone over-bets his credit. He can't pay; the bank calls his loan. His creditors don't get paid. When this mini-bust occurs, it infects other sectors that depend upon the flow of easy credit collateralized by real or imaginary profits.

Much misappropriated "wealth" just disappears into thin air, which is actually where it came from; but unfortunately ordinary people also suffer as producers of speculative production go bankrupt and misallocated workers lose their jobs.

Fearful people stop consuming until the bad credit is gone and equilibrium returns. This is the normal process, and if left alone it can take several painful months to wind itself down.

But Keynes and today's central bankers think they can outsmart the process. I can hear Keynes say, "Wait a minute. The warehouses are full and people are simply not buying. The wealth seems to be there, because production has already taken place. Somehow, the 'warehouse receipts' have been stashed, or misplaced, or destroyed by the bust mechanism, and all that is needed is for the central bank to prime the pump."

What he doesn't realize is that this Keynesian "solution" just creates more bad credit and throws it at consumers who--quite properly--just don't want to consume. This time, bad credit comes from both the Federal Reserve and the Treasury in the form of zero-interest loans, "stimuli," government purchases of private companies like AIG, and bank bail-outs, which further misallocates money distribution away from the real economy (that can't absorb it) and towards the speculators who know how to play what has now become a funny-money political game. While this is going on, the serious participants in the economy are laying low with uncertainty, wondering what the Fed, the Treasury, plus the IRS, Congress, the EPA, and all the other alphabet agencies, will do next.

Kipling, Stephens, and Melloan seem to understand this game and have tried to call the politicians' bluff. But the politicians will ignore them, because they have found they can fool most of the people most of the time, and a few they can't fool can be bought.

And this game of Pied Piper goes around and around until the people take back control of their money. And they are doing so, through the purchase of gold, gold-related instruments, and other such store-of-value investments. Hopefully, they will not let the government take that right away from them.

The People's Wisdom: A New Gold Standard

In a most insightful commentary published in the Financial Times of last Wednesday, Martin Taylor, himself a former banker, quipped:

"All business people know that you can carry on for a while if you make no profits, but that if you run out of cash you are toast. Bankers, as providers of cash to others, understand this well. They just do not believe it applies to their own business."

The reason bankers have trouble judging their own cash flow, he writes, is that "[i]n general, banks have no measures of cash flow that work for banking." He describes (with a great sense of humor) how bankers got us into this Great Recession by paying out "colossal accounting profits" in cash that were "largely imaginary.... Not only has the industry--and by extension societies that depend on it--been spending money that is no longer there, it has been giving away money that it only imagined it had in the first place. Worse, it seems to want to do it all again." (He's referring to the banking bonuses, which are at a new high.)

He ends the piece perfectly:

"How depressing the shame and folly of it all is, when one considers that the system was brought down not because risk management was deficient (though it was), nor because greed was rampant (though it was), but because bankers could not count. Merry Christmas."

This really states it all in one newspaper column.


[Thanks to Britannica.com for the image.]

It also causes one to think: Do we really want the world's money supply punch bowl to depend upon government-employed academicians and government-fed bankers, through a government/bank monetary power hierarchy?

For that is what we have today. With the too-big-to-fail policy, we now have fewer and bigger banks than we did before the crisis, and a government that is too worried about its own survival to care what happens to us, the Forgotten Men and Women. The Fed has been pumping billions of dollars into the banks and into certain markets, like the mortgage market. By doing so, the Fed is trying to juggle the general price level, the mortgage rates, and unemployment--to wit, the whole economy.

Taylor's astute observation about bankers' inability to judge their own cash flow is key here. The observation also seems to apply just as well to Federal Reserve bankers. As long as the Fed offers the opportunity to turn short-term credit into cash, bankers apparently will take advantage of it. This is Taylor's point. No one knows how full the punch bowl really is, nor do they care.

The Fed believes that it can judge the proper amount of created cash through observation of the CPI. But bankers' pay, no matter how outrageous, will never raise the general price level. So the upside potential for this game is limitless.

As long as the Fed's generosity only extends to the small community on Wall Street, they can continue to inflate the bonus bubble at will, along with the speculative and unfair redistributive profits their actions engender. No matter what they do to the dollar, to our savings, or to our purchasing power, they can say they were "just doing their job."

How can we protect ourselves?

In another very good Financial Times article entitled "On the flip side," written by Javier Blas, these lines jumped off the page at me:

"For the first time in decades, investors are allocating a fraction of their portfolios to gold on a long-term basis. That marks a return to normality, some argue. For centuries, gold has been central to savers. 'The aberration had been the last 20-30 years in which gold moved out of most investors' portfolios,' says Mr. [Jonathan] Spall [a director at Barclays Capital in London and author of Investing in Gold: The essential safe haven investment for every portfolio.]."

Once again, we the people are smarter than the politicians or the bankers. We have taken up a kind of individual gold standard, to take the place of the one the politicians and bankers destroyed when it got in their way starting in 1933 and ending in 1971.

Gold may be only a speculative commodity to some, but to many it is still an ideal store of value and the only weapon at our disposal to combat (1) political expediency, (2) the legalized embezzlement that is monetary inflation (with or without price increases--see this post and this post for more on this detail), and (3) bankers' inability to count.

I don't believe gold has hit its high yet. Push must still come to shove if and when the general price level does start to rise. At that point, to prove their goodwill and their capacity to control prices, the Fed would have to make a show of starting to increase rates and stopping "printing money;" but at the same time, they will have their other eye on unemployment.

If unemployment doesn't start to decrease, they will see their choices as between doing nothing, thereby allowing some inflation (general price increases as measured by the CPI), or raising rates thereby stopping the employment "stimulus." My bet is they will choose some inflation, in the wild hope that unemployment figures will improve soon.

Their inaction will signal to the marketplace that they will tolerate a further devaluation of the dollar, and gold will rise up again. How far this game will go is anyone's guess.

If the CPI remains low, they can continue to "stimulate" as long as the bond market will absorb it. This is also good for gold, and for the bankers, if somewhat less so for the Chinese, Japanese, Arabs, and the others who hold US bonds.

Remember:

You can take gold out of the standard, but you can't take the standard out of gold.

Devolution of the U.S. Businessman?

While reading a most interesting piece in the Financial Times called "Who won the revolution?" I was struck by a paradox of human economic behavior.

The article's author, Alec Russell, just revisited Romania twenty years after having first reported on the situation during the ousting of Ceausescu. The revolution was an apparent success; but according to Russell, the same power structure that existed back then remains in place today.


[Thanks to Roembus.org for the image.]

Instead of welcoming capitalism with open arms and starting afresh, the people somehow allowed the same corrupt elite to stay in power. During the transition these individuals were astute enough to keep their government connections alive and profit from them when the time was ripe.

Today, according to Romanian writer Stelian Tanase, who had dared to challenge the communist system under Ceausescu:

"'The best question to ask is who won the revolution: for Romania, the winner is the former nomenclatura [the high officials in Ceausescu's government]. They lost the revolution but won the power. The former promoters of communism simply became the promoters of capitalism.' He reaches for a copy of the Romanian edition of Forbes' Rich List, which details the country's richest people. 'Eighty-five per cent of the first 100 are former nomenclatura.'"

But how can that be, you ask. Very simple. It takes a Mafia mentality to run a communist government with any success, and for a wily Mafiosi, the transition from gangster communism to gangster capitalism is simply a change of name and of game plan. The underlying tactics and maneuvers are the same.

Russell also interviewed Mircea Chirila, a former security intelligence officer under Ceausescu:

"Is it fair that former Securitate officers are becoming big businessmen? It is, he contends, a natural trend. 'It is a biological evolution.'"

Ah yes. A Darwinian evolution. Survival of the fittest. This makes perfect sense.

My immediate next thought turned to Jeffrey Immelt's embarrassing mea culpa last Thursday in the Financial Times. Immelt seems to have been born again, preaching socialist-style "morality" from the bastion of capitalism on the other side of the globe.

No doubt, he is faced with pressures from shareholders and from factors within the current nationalization-inclined political majority. So instead of looking at history like a good Ayn-Rand capitalist and calling calmly and rationally for the preservation of free markets with stricter rules for fiscal and monetary policy, he flails himself in public and confesses to having succumbed to capitalism's supposed Original Sins--"meanness and greed."

But it's not that he has lost his mind. Just as the Romanian nomenclatura are evolving by adapting to the circumstances, he's simply evolving--or devolving as the case may be, in the Darwinian sense--to the new political culture.

The difference is that he's letting himself be drawn backwards towards centralized, socialized government. At least the Romanians have taken a step forward away from it. They have an excuse.

So what is Immelt's? Is he so vile as to have an ulterior motive? And if so, what does he hope to gain? And at whose expense? Why is he willing to sell America's freedoms down the river?

Francesco Guerrera's Financial Times article makes the answer to this question quite clear: "GE wants to win a large slice of the infrastructure projects funded by governments around the world in an effort to kick-start their economies." Oh, I see. So now we prostitute ourselves? Who is worse, the Romanians, or the American businessmen like Immelt who have sold their soul?

Ayn Rand's innocent, amoral businessmen must get a moral backbone. Mr. Immelt, Lloyd Blankfein, all you CEOs who are being attacked by socialist idealism through the lure of government assistance and political and financial pressure, don't let yourselves devolve into a new American nomenclatura. If you go down that road, you may live to regret it. (Just ask Ken Lewis.)

Bernanke Credibility

Bernanke is always a good target for a cartoon, especially now. So here's my latest.

(Click on the image for a larger version.)

The Treasury, the Fed, and Gold

Last week, two experts on the Treasury and the Fed gave a very interesting talk about the two entities' balance sheets. This is especially timely as the President is talking about applying the "leftover" TARP money to a new stimulus venture, and the Treasury is about to vote federal employees an unconscionable pay raise.

This conference was sponsored by the Cleveland-Marshall Libertarians and the Cleveland-Marshall Federalist Society and was called "U.S. Monetary and Fiscal Policy: Going Exponential."


[Thanks to Mathwarehouse.com for the image.]

Just to give you a taste, the following are excerpts from a good review by Kevin Lovach, the Co-Editor in Chief of The Gavel, CSU Ohio:

"[Walker] Todd is a former C-M professor who served as an officer of the Federal Reserve Banks of Cleveland and New York. He joined Case Western Reserve University Professor Emeritus William Pierce in analyzing the Federal Reserve’s monetary policies and federal deficit spending. Pierce served previously as Chair of the Case Economics Department and is a former Libertarian Party gubernatorial candidate.

"Stressing his view that the problems stem from Washington, D.C. and the banking-heavy northeast, Todd said 'the existing Federal Reserve leadership needs to be booted out.' He quipped, 'I’d like to see the Board of Governors hanged first, the New York Fed hanged second, Boston hanged third.'

"Pierce put federal deficit spending for the 2009 fiscal year at 9.9-percent, a figure topped only by spending during and immediately after World War II. He argued that while the economy can handle deficits of three-percent of gross domestic product 'forever,' anything substantially higher 'becomes real money.'"

For the whole review, see Page 9 of The Gavel for December 2009, which you can download at this Cleveland State University page:

The Gavel

To see the conference in its entirety, go to the following page and click on the links. They are around nine minutes each and well worth your time if you want to understand the problems and implications surrounding our exploding national debt and the current precarious Fed balance sheet. They also mention gold as a safe haven and discuss the few other options around.

U.S. Monetary and Fiscal Policy: Going Exponential