Western Standard

The Shotgun Blog

« "Judge tosses stunt-driving charge as unconstitutional" | Main | Revolt of the Ontarians »

Monday, November 23, 2009

The line between what we want and what is

I've come to realize something about human nature which seems to be an almost immutable trait; we tend to believe that everything will work out in the end, and only when we're faced with disaster, will we wake up to reality.

We believe absurd things in the face of overwhelming evidence to the contrary.

We accept the claims of the peddlers of "alternative medicine", despite the lack of scientific evidence for their efficacy, and tend to believe that the evidence exists, suppressed only by rich interests of the pharmaceutical industry.

We buy into the absurd claim that evolution is only a "theory"--misrepresenting what a theory in science actually means--in favour of a fairy tale involving a big bearded man in the sky that spoke some magic words and made the universe magically appear. 

However, it is not these examples of anti-intellectualism that I wish to explore here.  It is the anti-intellectualism that runs rampant around economics. 

The reprogramming has been widely successful.  We refer to government--specifically central banks--as "managing the economy".  When the economy goes bust, or even when specific businesses go bust, we cry to the government for action to correct the "failings" of the market.

In this, we've bought into the logical fallacy that there exists such a thing as  "market failure". 

We buy into the dogma that the economy is driven by confidence, and that a lack thereof, will lead to economic contraction.  A belief that seems true upon shallow examination of the evidence.  But it's a belief that doesn't really stand up to proper scrutiny.

This reasoning should immediately be suspect, if you really think about it.  It's pretty much the same principle of the mystical self-help book (and video of the same name) The Secret; if we all just believe the economy is okay and think positively, we'll all get rich and everything will be okay.  Most intelligent people realize this is absurd at the outset, but a surprising number of intelligent people accept that this is the case in economics. 

Economy is nothing more than the word we use to describe how a system of scarce resources allocates those resources.

Your body is an economy.  It is an economy of food, water, oxygen; the resources required sustain your life.  In the shortage of any of these resources, your body will make trade-offs, adjusting your body chemistry to best cope with the shortage. 

Certain things become more valuable in the shortage of other things.  For instance, in the economy of your body, the materials in your muscles are de-prioritized and put to use sustaining vital body functions in the absence of food.  Sweat production and saliva production will be curtailed to maintain fluid levels in the blood system in the absence of water.

Ultimately, we cannot sustain loss of any of these vital resources for protracted periods of time.  But the trade-offs are usually sufficient to give us the time necessary to locate new sources of these resources.  The sacrifice of muscle tissue to keep energy levels up long enough to find more food is much preferable to the quick death that might befall you in the absence of a mechanism to atrophy your muscles for this purpose.

We might summarize this basic economic principle with the old adage: short-term pain, for long-term gain.

When it comes to economics however, not many people live by or believe in this principle.  In fact, they believe the opposite.  Rather, they believe that economic contraction is a failing of government policy, rather than say, a necessary reallocation of capital from unproductive activities to productive activities along with a period of savings.

The mantra is repeated: spending is good. Which is to say, that saving your money is a bad thing.

The theory goes, that when consumers stop spending money, prices will drop and if prices drop then businesses will have to lay people off, and if people get laid off, the economy will contract, and we'll all be worse off. 

It's a theory that actually sounds pretty good.  But it glazes over basic economic principles to reach it's conclusion.  It ignores the possibility of wages dropping with price deflation, and that the standard of living is properly measured in terms of income vs. cost of living--a principle which many reject, for reasons unknown.

A drop in prices as a result of an increase in savings is not a bad thing.  But we've come to believe this as a fundamental basis of economic dogma.  But I'll prove you're wrong in two words: electronics prices.

The cost of computers, by any stretch has reached epic lows.  You can now buy a basic laptop for $300 (or less).  Many of us have powerful computers in the palms of our hands (iPhones, Blackberry's, etc).  The prices on these devices have been deflationary.  Yet, the electronics industry has grown by leaps and bounds. 

Enter: core inflation.

The argument is really that "core inflation" must be positive over time, or we're all getting poorer.  That, the price of food and housing in particular should rise.  If the price of food and housing do not rise, then we're all getting poorer.

Economists are saying that the long-term trend towards price deflation for consumer durable goods is irrelevant to the inflation picture.  But why?  We're told this all the time, but I'm yet to hear an adequate explanation.

If wages drop, then demand drops.  if demand drops, prices drop.  If prices drop to wage levels proportionately, then consumer buying power has not changed in relative terms.  So what's the big deal? 

The government relies inflation to deal with the fact that it's precipitously spending more money than the market will bear.  It's borrowing against the future by printing money instead of taxation, and counting on economic growth to offset the inflation, thereby reducing the debt.

Inflation is a devaluation of currency.  It is not a sign of wealth.  This is a lie, and it's imperative that more people start understanding this.

Inflation occurs because there's a larger supply of money than there is a demand for.   As a result, your savings account loses value; if you stuff the money under your mattress, you will find it's value is a fraction of what it was worth when you put it there.  Why? Because the government printed more money than was needed, thereby siphoning off the value.

Market forces do not work in real-time, and this is crucial to understand how the government is stealing your money right out of your wallet. 

When the government prints money and uses it to fund cheap debt in the market, the initial recipients of that money (the banks) are able to leverage that money at the current market value of money, before the additional supply of money debases the overall value of the currency.

So when the government prints $1,000 and spends it, the effects of that $1,000 debasement of the currency are not absorbed by the market until the supply of that money has been in the market for some time.  So when the government prints the money, it's worth $1,000 at current market value.  But a year later, assuming a 3% inflation rate, those notes are worth $970.  They're arguably worth less than that if you factor in rising energy costs (which they don't) but we'll entertain the orthodoxy for now. 

The point is that the buying power of all saved currency lost $0.03 in that year, and for no other reason than the fact that the government printed money, introducing excess supply which leads to the debasement of the currency.

You might say: so what?  Even if I buy your "deflation is not necessarily bad argument", inflation is not necessarily bad either, since wages tend to rise too.

This is true.  But the point is, that the inflation of wages tends to lag far behind the inflation of the currency.  Thus, enabling the initial purveyors of this printed money to take advantage of the dollars at their maximum purchasing power.  By the time we all "benefit" there has been a period of inflation where we have experienced higher prices at lower wages.   The inflation has also essentially coerced us into risk taking.

We all understand that if we simply keep our money in our savings account, we'll be too poor to retire.  It's generally understood we must invest our money to have a comfortable life beyond our working age.  But the only reason this is true, is because of inflation.

Thus, the arbitrary printing of money provides market incentives towards risk taking that would not otherwise be taken in a market of stable money. 

For those people with their trusty savings account, price deflation means they've gotten richer.  Not poorer.  And this increase in real savings means there is more real capital available for lending. 

The other argument against deflation is that once perceived, consumers will become attuned to the drop in prices and perpetually put off spending, waiting for the prices to get lower and lower, leading to a complete halt of the economy.

How many of you have put off buying a computer year after year, waiting for the price to get lower?  I mean, we all know that prices get lower on computers every year.  We always moan and grope to each other about how much our LCD TV cost us say, $2000 a year ago, and now sells for $999.

Price deflation did occur in food prices in Canada in the past year, according to Statistics Canada.  And yet, Metro and Loblaw's--Canada's biggest foodchains--posted record profits.  How can this be? 

It can be for one simple reason: the economic orthodoxy against price deflation is utter bullcrap.

So where does the fear of deflation originate?

It originates from the fact that deflation has been associated with economic recessions and depressions.  But deflation is nothing more than a symptom, not a cause of, economic restructuring.  It is only a matter of convenience that governments cling to this message, as inflationary monetary policy is key to government spending at levels that exceed the tax base.

Moreover, it is not that deflation or inflation are either bad or good.  It is the fact that the government attempts to control them that is bad.  That, we deny the efficacy of market forces to reallocate capital in efficient ways.

Intentional introduction of inflation--which is what low-interest on treasury loans are--results in miscalculated risk taking and inefficient capital allocations--collectively referred to as market distortion.

The term "market failure" is used to describe say, the subprime mortgage crisis.  What statist government-planner types call "market failure", us free market types call "market correction", which is to say: market forces are at work to clean-out the misallocation of capital from unproductive use.

Market corrections are painful. Their symptoms can include bankruptcies of large corporations, mass-layoffs, and an increase in personal bankruptcy.  But it is not a failure of the market that these things happen.

It is a failure of the home buyer who bought into a variable interest loan, without the financial capacity to bear a significant increase in interest.

It is the failure of a business which took significant risks that resulted in the loss of wealth.

It can even be a failure of labour unions to acknowledge that wage concessions may be necessary to allow their employer to remain competitive. But not always.

The truth is, that when capital is locked up in an unproductive enterprise, it is doing you and I no good.  Having the government come in and save a company which is losing money, is not saving jobs.  Rather, it's decreasing the overall productivity of the market, by promoting the continued concentration of capital in that unproductive endeavour.

When we think about the thousands of lost jobs from a failed company, we have a tendency to overlook the fact, that by allowing the company to fail, and allowing creditors to take their losses, and take out what capital they can, we allow that money to be transferred to more productive uses, like say, profitable companies.

Also, the moral hazard that has been introduced by the bailout of companies goes far beyond the scope of the behaviour of individual companies.  It goes right to the behaviour of individuals.

Instead of saving money for a rainy day, such as in the case of a disruption to your income, we run our credit cards up to the hilt, and save nothing.   Most people, even people in relatively high-income brackets, live paycheque to paycheque.  And largely because we count on government to ensure we don't fall flat on our face.

While not bailing out the economy would have been a shock to us all, it would have encouraged saving, rewarded those who did save (through price deflation) and it would punis those who took unacceptably high risk.  The lessons we would learn from that would be far more effective than any regulation the government could enact.  But we've convinced ourselves that we can live pain-free.

We're convinced the government can run up debt endlessly, that consumers can run up debt endlessly, and that we can run up massive trade deficits, continuing to leverage our economies more and more, borrowing money from China so we can use the money we borrow from them to buy stuff back from them.  That, we can effectively have nothing to sell to China, but buy everything from them.

None of this makes any sense.  But that's the world we live in, and we're heading for disaster.  But that's the way we like it: "irrationally exuberant" until reality faces us down.

We may be seeing signs of recovery.  But we're just getting started in this growing economic disaster.  We're on a one-way trip to disaster, because we've deluded ourselves into believing that we can have it all and not have to pay for it.  That's what it comes down to.  It's as simple as that.

Posted by Mike Brock on November 23, 2009 | Permalink


Excellent post Mike.

If you'll allow, I'd like to introduce another massive fallacy which has been making the rounds since the 1930's. We've been told that savings is bad. We've been told over and over that when savings exceed investment opportunities, that recession occurs. This is another pile of crap. The curve for investment opportunities is not verticle, its slope is negative and the curve is diagonal. Any entrepreneur or anyone who's worked for a major corporation can readily attest that there are many more investment ideas than there is capital. What regulates the access to capital are interest rates (which are a function of savings and demand for those savings).

Another fallacy: people don't stuff their savings under the mattress (which wouldn't be a good thing), they invest it. Even a savings account is an investment since the bank lends out the money and sustains the economy while increasing our capital stock.

Finally, one minor quibble. In a deflationary period, it is entirely possible to have a rise in salaries and incomes. In a competitive labour market, increases in productivity are associated with increases in income and salaries. Think of the computer industry, even with falling prices, incomes and salaries are going up.

Posted by: Charles | 2009-11-24 5:41:50 AM

I just realized I may not have been clear in my last paragraph. If prices are falling, it means the volume of products/services is increasing. It is therefore entirely possible to have falling prices and increasing revenues (the increase in volume more than making up for the fall in prices). It also follows that in a competitive labour market, the worker would be able to extract his piece of the increasing profits.

Posted by: Charles | 2009-11-24 7:44:30 AM

Actually Mike, I consider myself an intellectual and unfortunately I live in rural alberta. There are many problems here:

A We have a Creatioist museum here
B About 80% of people believe in Genisis
C People think the Theory of Evolution means humans come from monkeys
D Many people think their is a gay/feminist conspiracy to take down the province
E Educated people are looked down upon
F People can't mind their own busines

On this blog their are quite a few wackos. I assume you know the work of Dr. Shane Matthews and Zebulon Pike.

Posted by: Doug Gilchrist | 2009-11-25 7:08:00 AM

The comments to this entry are closed.