Submitted by David Stockman via Contra Corner blog,
The world’s official economic institutions are run by people who believe in monetary fairy tales. The 70 words of wisdom below from IMF head Christine Lagarde are par for the course. She asserts that a new jabberwocky expression called “low-flation” is the main obstacle to higher economic growth in Europe and the DM areas generally and that it can be cured by more central bank money printing.
The first obstacle is… the emerging risk of what I call “low-flation,” particularly in the Euro Area. A potentially prolonged period of low inflation can suppress demand and output—and suppress growth and jobs. More monetary easing, including through unconventional measures, is needed in the Euro Area to raise the prospects of achieving the ECB’s price stability objective. The Bank of Japan also should persist with its quantitative easing policy.
Now there is not a shred of credible evidence that prolonged low CPI inflation causes workers to produce less, businesses to invest less or entrepreneurs to invent less. Since these are the fundamental ingredients of economic growth on the free market, the question recurs as to why Keynesian Kool-Aid drinkers like Lagarde (and the huge staff of IMF economists she lip-syncs) apparently believe that eroding the value of savings by say only 1% per year vs. 2% will “suppress demand and output”.
Obviously, even they can’t believe that falling prices alone cause “demand” to falter. After all, the price of flat-screen TVs, iPads and iPhones have plunged during the past several years, but demand has soared. During the past 27 months, for example, Apple’s revenues have surged from $29 billion to $58 billion per quarter.
And its not just tech gadgetry, either. Wal-Mart has been driving down the price of furniture, toasters and house-paint for years now, but it has never once complained that its revenue growth–which has been relentless for decades—-has been impaired because its customers are holding-off for even lower everyday prices next period.
Indeed, at the product and commodity level the “low-flation” notion is positively ridiculous. US auto sales of 17 million annually in 2005 plummeted to about 11 million by 2009, but that was due to falling incomes and impaired credit status among marginal car buyers. During that period auto prices were not falling but steadily rising.
In general, the old rules have not been repealed: demand flows from income; income follows production; rising prices except among the most inelastic commodities tend to discourage demand; and falling prices tend to stimulate it.
Only in the Keynesian world of regression model aggregates do we get a polar-reversal. There, baskets of prices (i.e. price indices like the CPI) which are rising somewhat slower than trend allegedly cause that mysterious ether called “aggregate demand” to falter. Needless to say, the professors have never identified the transmission mechanism whereby the consumer’s logical behavior to buy more goods with falling prices at the micro-level— causes the sum of all consumers to defer spending in the face of weakening inflation at the aggregate level for the entire basket of goods and services.
No time needs be spent on puzzling about this conundrum because the missing link is easy to see. The mysterious Keynesian ether is simply credit expansion in excess of income growth. That happened for about four decades prior to the financial crisis, and it did goose GDP as measured by the ”spending and income” accounts published by the government’s statistical mills.
Designed by primitive Keynesians in the 1930s and 1940s these ledgers were a marvel of aggregation, cross-walks and accounting identities, but, alas, they suffered from a irremediable flaw. Namely, the GDP accounts contained no balance sheets; it was all about flows which meant that there was no history, and that each quarterly accounting period was a fresh start.
As it happened, the US economy fresh-started its way straight up a parabolic debt-to-income curve after the 1970s. The aggregate credit market debt-to-national income ratio had been stable at 1.5X for nearly a century, but climbed nearly continuously to 3.5X by the eve of the financial crisis in late 2007. As I have demonstrated elsewhere, this extra two turns of debt amounts to about $30 trillion of incremental debt burden.
In the household sector, the debt ratchet was equally dramatic. With each new business cycle, household debt climbed to a new plateau. It ultimately rose from 80% of wage and salary income in 1970 to a peak of 210 percent in 2007—before falling back slightly to about 180% at present owing to the liquidation of unsustainable or defaulted mortgage and credit card debt.
The short of it is that we have hit peak debt, and the one-time ratchet to spending based on rising debt ratios is over. The Keynesians never saw this coming because their DSGE models never saw a balance sheet—let alone the de facto LBO which occurred on the nation’s aggregate balance sheet over the past 40 years.
And so they persist in insisting that more of the square peg of debt be pounded into the fully saturated round hole of income. That’s the essence of the mad money printing being undertaken by all of the world’s major central banks.
Keynesian policy-makers at these central banks labor to once again levitate demand in the time-worn manner, but fail to see that the credit transmission channel of monetary policy was a one-time expedient, and that it is now exhausted and done. After nearly five years of failing to achieve “escape velocity”, therefore, they now desperately need an explanation for that failure, and have simply invented one: “low-flation”.
It goes without saying that this particular variant of the Keynesian catechism is especially dangerous. It gives the central banks a license to define and redefine “optimum” inflation—a figure that is already creeping up from 2% toward 3% and even 4% among some of the more aggressive doves. Since the phony inflation numbers published by the government mills–riddled as they are with imputed rents, geometric means and hedonic adjustments— will always fall short of these arbitrary inflation targets, the central bankers have essentially invented a pretext for endless monetary expansion.
Unfortunately, that means that the Wall Street finance channel will be injected with ever more juice for the carry trades until the resulting financial bubbles reach their natural asymptote and come crashing down once again. The scary thing is that the world is being run by central bank, IMF and national government apparatchiks, who, like Christine Lagarde, are clueless about the fact that momentary doctrines such as “low-flation” are simply made-up claptrap.
Too be sure, the Keynesian recipe for the debt elixir was not always this specious. Once upon a time this Keynesian RX was at least quasi-honest because the debt magic was held to operate mainly through fiscal policy. According to the great thinker, the masses had an unfortunate habit of saving too much—-so the solution was for the fiscal authorities to sop-up these fetid pools and cycle them back into the economy through government deficits.
In turn, these fiscal booster shots in the form of transfer payments, public works, war equipment and even holes dug and refilled would generate fiscal multipliers—that is to say, money borrowed from society’s stagnant savings pool and spent by recipients of government outlays would become new income to shovel suppliers and food vendors, who would re-spend their proceeds and fuel a virtuous cycle of growth.
Moreover, this type of prosperity from the issuance of government bonds and bills was to be pursued aggressively until the macro-economy had absorbed every single idle worker and capital resource, and had thereby achieved a Keynesian nirvana called “full employment”. Only then was the borrowing to stop, allowing the budget to swing into full-employment surplus. At that point, the macro-economic bathtub would be full to the brim and the elixir of debt would have done its job.
It didn’t work out that way. Johnson’s “guns and butter” fiscal policies caused the macroeconomic bathtub to flood, unleashing a decade of the Great Inflation. Unemployment dropped below 4% for 40 months running in the late 1960s, giving rise to virulent wage pressures that fueled an inflationary cost spiral.
Likewise, the excess domestic demand feed by the Keynesian doctors of the Kennedy-Johnson White House spilled over into the international market, inducing a massive inflow of imports and current account deficits. Soon there was a monetary crisis. Nixon then pulled the plug on the gold-backed money that J.M. Keynes had designed at Bretton Woods, thereby permitting Milton Friedman’s monetary wise men to run the nation’s central bank by the seat of their pants.
In time, the excess savings hobgoblin disappeared–with the US household savings rate falling from 11 percent to barely 3%, but that didn’t matter. The Keynesian baton had already been passed to the Greenspan era central bankers. As suggested above, the latter proceeded to fuel massive credit-driven expansion until balance sheets were fully exhausted.
At the end of the day, therefore, the grand Keynesian idea of the debt elixir has now been reduced to mindless money printing by the central banks. And the myth of excess savings and under-consumption has been reduced to something even worse—bureaucratic slobbering about “low-flation”.