The Unleashing of Madness

A number of articles have recently discussed the ECB’s quantitative easing program, which entails inter alia the buying of covered bonds. Here is a quote from an article in the Financial Times:

“The European Central Bank has started to buy covered bonds, in its latest attempt to to revive lending in the euro zone and stave off a vicious bout of economic stagnation.”

It would be more correct to write: “ECB tries its best to revive the credit bubble that thankfully expired in 2008”. This one sentence from the FT above encapsulates already almost everything that is wrong about these currency debasement programs. It is presented as a “given” that central bank meddling with money and credit is necessary to revive, or as it is often put, “jump-start” the economy, which is held to be mired in stagnation for generally mysterious reasons.

And yet, his comment by the FT makes as much sense as the policy, namely zero (a big, fat zero). The ECB will effectively print money, or rather, create digital money ex nihilo, to pay for these purchases. The underlying assumption that creating additional amounts of money can “stave off economic stagnation” is 180 degrees wrong. It will achieve the exact opposite, namely a structural weakening of the economy – even if, or rather, especially if, economic activity as measured by aggregated data seems to “revive” as a result.

Those who have first access to the newly created money can exercise a demand for real goods without first having contributed anything to the economy’s pool of real funding. This makes it more difficult for those people who actually do make such contributions by their productive efforts to create wealth – as they are forced to compete for a shrinking pool of real resources. As Frank Shostak explains in recent article, what happens is that “exchanges of nothing for something” result from the creation of additional money:

“Before an individual can exercise demand for goods and services, he/she must produce some other useful goods and services. Once these goods and services are produced, individuals can exercise their demand for the goods they desire. This is achieved by exchanging things that were produced for money, which in turn can be exchanged for goods that are desired. Note that money serves here as the medium of exchange — it produces absolutely nothing. It permits the exchange of something for something. Any policy that results in monetary pumping leads to an exchange of nothing for something. This amounts to a weakening of the pool of real wealth — and hence to reduced prospects for the expansion of this pool.”

(emphasis added)

The idea forwarded by central bankers and their claque of apologists that “demand” is somehow “deficient” is utterly risible. Unless all human wants are already fully satisfied, there is a very long list of “demand” for goods and services. Surely nearly every human being in society (exceptions are perhaps the occasional hermits in mountain caves who have sworn an oath of eternal poverty and silence) has such a list of things they would like to have in his or her head. People even have demands they don’t know about yet, because the relevant goods haven’t been invented yet. Consider the nowadays ubiquitous smart phone. Before it was invented, demand for it was zero. We can undoubtedly all agree that demand for smart phones is no longer zero these days.

The ECB’s governing council on the marble steps of the monetary policy temple in Frankfurt. They are the modern-day version of the priestly classes of yore. The main difference is that their pronouncements are based on looking at “data” instead of the patterns made by chicken bones or the entrails of sacrificial animals. Unfortunately the theories on which the priests base their verdicts and decrees seem not to have evolved much.

(Photo credit: ap/lapresse)

Just as ridiculous as the notion that we suffer from a “demand deficiency” is the assertion that the proper way tospur said demand is to make goods and services more expensive rather than allowing them to become cheaper.

This is what the perverse deflation-phobia of central bankers in effect means: they are not only putting the cart before the horse by asserting that “spurring demand” will magically “spur production”,  in addition, they are actually standing the laws of supply and demand on their head.

Perhaps someone, somewhere, knows people whose willingness and capability to buy more goods increases when these goods become more expensive. Maybe they live in some Bizarro dimension we haven’t discovered yet? Who knows really. Meanwhile, the rest of the world (approximately 99.99999%, including central bankers themselves) is hunting for bargains and “everyday low prices”. If it were otherwise, Wal-Mart would not exist.

How devastatingly ridiculous this particular line of argument forwarded by these brain-dead charlatans is came home to us again when Mish mentioned another recent article in the FT entitled “Eurozone fails to benefit from weak currency as oil price slides.” There it is intoned sotto voce:

“The weaker exchange rate will ease pressure on the ECB in its fight to raise inflation back to its target of just below 2 per cent. Mario Draghi, the central bank’s president, has said the currency’s earlier strength explains 0.4 percentage points of the fall in inflation since 2012. In that year, prices were growing 2.7 per cent a year.

But just as this depreciation is starting to fuel inflation, the ECB must contend with a fall in oil prices that all but wipes out the effect of a sliding currency. A weaker euro should swiftly raise the cost of imported energy. Instead, Brent crude has fallen 9 per cent in euro terms this month alone. This is the main reason why eurozone inflation fell again in September to 0.3 per cent, a five-year low – a figure confirmed by data on Thursday.

“The drop in oil prices is a problem for the ECB,” says Marco Valli, an economist at UniCredit, adding, however, that the situation would have been far worse without the single currency’s fall.

(emphasis added)

So these bien pensants have concluded that “falling oil prices are creating problems for policymakers in the euro area in their struggle against deflation, luckily though the euro has declined sharply, lest they would face an even bigger problem“.

Yes, what a stroke of luck. Due to the ECB making every foreign good and service more expensive for the citizens of the euro area with its monetary debasement policy, Europe has managed to avoid reaping some of the dubious benefits of lower oil prices! They have made us all richer!

Not to put too fine a point to it (it is too late for that anyway)  – we are evidently in the capable hands of a bunch of complete and utter morons.

Declining oil prices and the falling euro (via StockCharts): allegedly the former is bad for Europe’s economy, while the latter is good! Common sense has evidently left the building 

 The Balance of Trade and Misdirected Production

In the Financial Times article cited above, the authors are wondering why what is supposed to work “in theory” seems not be working in practice:

“A cheaper euro will also please business leaders who have long called for action to curb the value of the currency. But economists warn it is hard to tell how far this bout of depreciation will help the region’s anaemic recovery.

In theory, a rise in company profits should support business investment, hiring and consumption. But analysts warn that the relationship between exchange rates and export volumes is far from clear-cut.”

First of all, who are those unnamed “business leaders who have long called for action to curb the value of the currency”? The only businesses that benefit – very temporarily we should add – from currency devaluation, are those primarily engaged in exports. These benefits are ephemeral and exist only for as long as it takes for internal prices to adjust. Moreover, they come at the expense of the entire rest of the economy, including every single consumer. So the expected effect of “rising company profits” that should lead to “more investment, hiring and consumption” is strictly confined to those in the export trade. Everybody else will see a decline in their fortunes.

Think for instance about companies that import the goods they are selling from abroad or import parts from abroad that are needed in their manufacturing processes. Obviously, they won’t reap any benefits at all. Instead of undertaking new investment or start hiring new employees, they will do the opposite. As Ludwig von Mises stated about the alleged benefits of currency devaluation:

“The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption. This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation’s welfare.

In plain language it is to be described in this way: The British citizen must export more British goods in order to buy that quantity of tea which he received before the devaluation for a smaller quantity of exported British goods.”

(emphasis added)

It should be obvious that the balance of trade is not “the yardstick of a nation’s welfare”. Countries don’t trade with each other, individuals do. National borders are entirely incidental to this process and have no economic significance whatsoever. Since trade is voluntary, it follows ipso facto that every trade is regarded as profitable by those engaging in it. If that were not the case, no trade would take place.

As Frank Shostak mentions in his article (which refers to a speech delivered by Minneapolis Fed president Nayarana Kocherlakota, whose views are however not different from those of monetary bureaucrats elsewhere):

“It seems that the Minneapolis Fed President holds that by boosting the demand for goods and services — by means of additional monetary pumping — it is possible to strengthen economic growth. He believes that by means of strengthening the demand for goods and services the production of goods and services will follow suit. But why should that be so?

If by means of monetary pumping one could strengthen the economic growth then it would imply that — by means of monetary pumping — it is possible to create real wealth and generate an everlasting economic prosperity.

This would also mean that world wide poverty should have been erased a long time ago. After all, mostcountries today have central banks that possess the skills to create money in large amounts. Yet world poverty remains intact.”

(emphasis added)

This little flaw in the theorizing of central bankers is never adequately explained by them. If pumping up the money supply can improve economic conditions, why isn’t the world a Utopia of riches yet? Should not Zimbabwe and Venezuela be the most prosperous nations on earth?

It is of course undeniable that pumping up the money supply affects the economy. Many investments are undertaken that would normally be eschewed if not for the price revolution that monetary pumping engenders. This may make it appear for a while that “economic growth” is increasing, but what is reported as growth in GDP and other aggregations of economic data really is a Potemkin Village that masks the fact that capital is consumed. In reality the process is not any different from Keynesian ditch-digging: if the government were to hire 100,000 people to dig useless ditches all over the country, its statistics would boast of “falling unemployment”. And yet, no-one would consider that anything worthwhile has happened, or that anyone’s prosperity has actually increased.

The notion that “boosting demand” will automatically lead to increases in production (and all it entails) is based on an erroneous view about the nature of capital. Capital is not a homogeneous blob that is just waiting for increases in demand to swing into action. The economy’s capital structure is a fine and complex latticework of heterogeneous capital goods, that need to work together to produce an optimal outcome with respect to the future demands of consumers.

The coordination of this complex process of production is ensured by correct price signals. These signals tell entrepreneurs which investment activities should be undertaken, by allowing them to calculate and compare the various alternatives. Whether an inventory of copper should be used to make copper statues of central bankers or copper wiring for houses can only be determined by comparing the opportunity cost involved in employing copper for either of these alternative uses.

However, once an expansion of money and credit is set into motion and interest rates are artificially suppressed, relative prices in the economy inevitably begin to shift. Economic calculation is consequently falsified, and investment and production are misdirected. After some time, the entire production structure finds itself in disarray: too many things that are not wanted by consumers are produced, while not enough is made of those that are actually demanded more urgently.

Once the veil of illusion created by monetary pumping is rendered asunder, an economic downturn ensues, as entreprenuers are desperately trying to make things right again. Inevitably though, the process of capital malinvestment will have unnecessarily destroyed some of the real wealth that could have been employed in creating genuine economic progress. Piles of inventories that can no longer be sold at the prices that were originally expected, machines and factories that can no longer be profitably employed due to a lack of complementary capital, buildings and factories that remain unfinished because the real resources required for their completion actually don’t exist, all bear silent testament to this.

Conclusion:

No doubt something should be done to improve economic conditions. Printing more money and manipulating interest rates and currency exchange rates are however only apt to make things worse. What is really needed is an increase in economic liberty.