Exorbitant Privilege & Unlearned Lessons

Pace those who have made such a big deal out of Chairman Bernanke’s November 19^th speech, but it is hard to find anything therein other than the usual rehearsal of super-aggregative error and unabashed American blame-shifting.

To our mind, it was hardly news that Blackhawk Ben felt that the world monetary system contained a ‘structural flaw’ – nor, indeed, that he completely misidentified its essence. It may be too uncomfortable a truth for him to face, but this is a problem which does not consist solely of the malign outcomes of surplus countries trying to peg their exchange rates, per se, so much as of the fact that there is no effective constraint on the OTHER side of the transaction – at least, not for large economies in general and for the provider of the world’s reserve medium, the United States, in particular.

The existence of such a wilfully ‘loosened joint’ between the supply of and demand for goods and services should be contrasted with the system which prevailed before the Great War (one is tempted to say, for the greater part of human history) under which an equilibrating pressure was at least theoretically delivered by the need to settle net trade imbalances between two regions with a genuinely scarce, OUTSIDE money such as gold or silver (whether in the form of specie or bullion) and not by means of the near-costlessly replicated IOUs of its biggest spendthrift.

As the redoubtable Jacques Rueff was always at pains to point out, the present regime, whereby the world’s largest excess consumer can painlessly force an increased issue of its liabilities onto its hapless counterparties, is a ‘childish game of marbles’ (i.e., one in which the ‘winners’ must always surrender their gains to the ‘loser’ at the end of each round); one in which the most persistent and largest DEFICIT offender faces few immediate consequences of an habitual irresponsibility which can, on occasion, degenerate into outright rogue behaviour (‘It’s our currency, but your problem!’).

Indeed, the unbridled enjoyment of just this facility – of this self-assumed prodigal’s charter – is something which has indisputably tended to discourage non-inflationary investment in the very industrial capacity needed to provide that extra quantum of valuable goods and services which would either have competed more efficiently with that same nation’s imports or paid for more of its exports – a point all too conveniently overlooked by the Fed and its serried ranks of apologists.

While we should be careful lest we impose our preferences on those of others, trade – whether within or across borders – tends to deliver greater and more lasting mutual gains when each party freely exchanges elements of its produced wealth. When one of those involved is habitually persuaded – or coerced – into conducting such dealings on tick with a truculent profligate who is bound ultimately to renege on what he owes – who, indeed, feels he is doing his supplier a favour by relieving him of his goods in the first instance – it is more than a little hypocritical to berate the seller-creditor, not the buyer-debtor, when things do eventually go wrong.

For Bernanke to criticize the surplus nations is thus nothing new at all – it is, au contraire, perfectly consistent with the long-held US policy of whining at its trading partners whenever they fail to mimic, in sufficient degree, its own chronic inflationism. It is an act of special pleading  on a par with the Chairman’s ludicrous notion of a ‘global saving glut’ and, moreover, it represents a full and sycophantic toeing of the Administration’s line that those who are most successful at meeting global customer demand (not infrequently under the ownership of American shareholders and subject to the guidance of American management expertise, it should further be noted) should, on that account, be penalised for those same customers’ inability or unwillingness to offer anything other than irredeemable promises of future compensation in exchange for the wares they so eagerly snap up..

Notable, too, in the arguments of a man who shares the implicit, Keynesian/Monetarist delusion that consumption is a source of wealth – rather than comprising the act of its final extermination – is the notion that adjustments must always incorporate increased spending on such an eradication of worth, even if this comes at the added cost of providing governmental subsidies to encourage it (in the form of ensuring greater availability of just that  same ‘retail credit’ whose lavish extension helped trigger the global crisis, in combination with the strangling coils of a strengthened ‘social safety net’ – i.e., with the imposition of the same kind of Ponzi scheme welfare state whose spiralling costs and perverse incentives are presently throttling  the West’s recovery and the threat of whose most minuscule reduction has already provoked open violence on its streets).

Mr. Bernanke should also ask himself what would happen to American standards of living were the Chinese, the Arabs, the Germans and the rest to take him at his word. If this meant they were henceforth to use their surplus dollars directly for consumption, rather than channelling them toward the kind of unthinking vendor finance which has helped suppress world prices for so long, with money already so easy, his country would face an inflationary wave which its hollowed out industries could not easily expand to counter. If America is being ‘impoverished’ under present policies it is because their settings encourage it to consume too much of its precious capital. Given this premise, we cannot expect that same capital to materialize instantly and to begin pouring out a plethora of cheap goods the moment the external tap is turned off. Nor is it certain – as the argument implicitly assumes – that (outside the farm belt, at least) the extra spending would find its way into US cash registers instead of being shared out between the great producing nations themselves in a kind of BMW-for-oil-for-plasma-TV triangular trade.

Conversely – though far less conceivable in practice – each of these great world suppliers could start to eat a much greater share of their own cooking. To see what this implies, let us push it to an extreme and envisage it taking the form of a total export ban. Given the recent brouhaha over a handful of Rare Earths, and the more significant dislocations caused when certain governments impose their rice or sugar embargos, can you imagine the howls of pain which would emerge if this denial of custom extended to some goodly part of the $1.8 trillion the US buys abroad each year?

A further implication is that, given the near universal prejudice the mainstream holds against ‘deflation’ – i.e., falling prices – even when this reflects genuine market signals regarding the beneficial attainment of increased prosperity through higher material productivity – the idea of ‘burden sharing’ is rendered even more suspect since it beggars belief to suppose that deficit countries would ever allow reserve-driven credit contraction to take place. Indeed, with the exception of his rehearsal of the empty formula that US fiscal (but never its monetary) policy may need to be trimmed back (though not just yet, of course), Bernanke devotes most of his time arguing that, as has been the case at least since WWII, surplus countries can do nothing other than to swallow whatever reserve-driven degree of credit inflation the US forces down their gullets, regardless of the havoc this unleashes upon the general populace (of whom only some fuzzy minority will be counted among the evil exporters being targeted, in any case).

Quite how this asymmetrical transmission of a faulty macro-policy of free-riding is supposed to speed the proportionate adjustment of relative prices – and hence the optimal allocation of capital – around the world is not at all clear.

Even more tellingly, the introduction of a truly improved system would imply the acceptance of a semi-automatic mechanism wherein the central bank (to the extent one is actually still needed) would exist simply to facilitate cross-border settlements and – in the case that the local currency is not fully convertible (and coinable!) on demand by its users into some scarce, external monetary asset – to help regulate the value of the former so as to maintain its relevant, contractual parity. This clearly requires that all ideas of ‘dual mandates’ regarding the level of employment – as well as all the other hubristic, Gosplan-style programmes and corporatist feather-bedding presently countenanced – would have to be abandoned. Such a drastic diminution of function and importance is not something the self-perpetuating bureaucracy of the Fed – not to mention the equally otiose apparatchiks at the US Treasury, the IMF, the WTO, and all the other supranational, alphabet soup of busybodies – would at all relish, one presumes.

It must also be emphasised that the necessary corollary to this overthrow of the present pernicious monetary apparatus is that if we are then to avoid the triggering of a self-aggravating collapse whenever any resulting restriction does begin to bite, the maximum degree of domestic price flexibility must be induced in the system – i.e., wages and prices must all adjust without interference from either central banks or governments as rapidly and as uninterruptedly as possible.

Without such a resolve – though its adoption may well run counter to the sophistry of the predominant Progressive creed espoused by our rulers – we are only half way to our goal. Just as in bridge construction, half-solutions in these matters are not only no solutions at all, but entail even greater hazards to those undertaking them. Were we to attempt the one without the other, the inevitable failure would surely risk a further eighty years of the counter-productive denial of the workings of economic law by two further generations of Nobel laureate, idiot savants!

Though he later recanted his belief in its message, Lionel Robbins’ near-contemporaneous treatment of events in his ‘Great Depression’, remains one of the most cogent and lucid expositions of what went wrong in that dark decade and also of what kept it in a state of ‘wrongness’ for such an unconscionable length of time after the initial crisis.

Among its many, telling comments, the following stands out by way of its relevance to the turmoil taking place in Europe today and so is worthy of an extended reproduction here:-

“……The boom was remarkable, not only for the proliferation of fashionable fraud; it was remarkable, too, for a change in the methods of straightforward financing… by a conspicuous increase in the proportion of public investment which takes the form of fixed debt rather than participating ownership. This tendency was bound to accentuate the difficulties of any period of depression. In part, the change was due to… increased participation by banks in the financing of all kinds of enterprise created a market for bonds where equities would have been unacceptable…The big insurance companies, moreover, through whose agency so large a proportion of the savings of the poorer and middle classes are invested, had a preference for this kind of investment…”

“But in part it was due to the increased economic activity of States and governmental bodies. The most intractable and disastrous masses of fixed debt which have obstructed recovery in the slump have been debts of this sort…   Of the total amount invested in Germany in the years 1924-1928, it has been estimated that at least 40 per cent was on account of governmental bodies. Much of this was spent on the carrying out of works such as the construction of swimming-baths, the financing of housing schemes and so on, which had little prospect of being financially remunerative… Much of this money is irretrievably lost. But, because it was borrowed by government bodies, recognition of this fact is slow to come and liquidation has thus been delayed. Paradoxically enough, economists who have urged that this sort of thing has not proved its worth in practice, are often called by their opponents, ‘deflationists’…”

Is it so hard to see that, when the crisis broke, the Irish authorities should have restricted themselves to guaranteeing banking deposits up to some fairly modest ceiling amount and then left bank shareholders, bondholders, and wholesale depositors to negotiate over the division of whatever small residuum their ill-advised investments had left them?

By extension, if and when those creditors themselves were sufficiently embarrassed as a result of their folly, the authorities in their own jurisdictions – whether German, Dutch, French, British, or whatever – should have applied exactly the same salutary treatment to them in their turn. Losses would undoubtedly have been substantial, but the foredoomed attempt to disguise them has not only not made these any lesser, but has prevented anyone from embarking upon the process of working to put right the shocking loss of wealth they have entailed in the interim.

Yes, there would have been considerable disruption and a highly regrettable hardship would have been imposed not just on the few, highly-visible ‘Rich’ but also on the many, nameless, less well-off – but can anyone say that today’s consequently pressing need to throw the engine of government debt accumulation violently into reverse will not occasion at least equal amounts of suffering in a far more protracted manner and without even the merit of fairness and equity in making the malefactors’ willing business partners bear the first (and probably the largest) portion of the losses?

As it is, the Irish ‘rescue’ looks like it has only served to underline how perilously entwined the fortunes of sovereigns and their banks have become. As we have noted before, under the rules of this multi-trillion shell game, the sovereigns guarantee the ECB which funds the banks which buy the government debt which provides for everyone else’s guarantees.  No wonder scrutiny is switching back to Spain and Eurobank stocks are sagging, once more.

And to think that the former UK Prime Minister used to boast that he had ‘saved the world’ when he set the standard by being the first to rush to conclude a similar pact of mutually-assured destruction into which the hosts of cherubim and seraphim, surely, would have feared to tread.

As if this were not enough for markets to try to rationalise, there is just the risk that it travels back  to the US – whether via the ‘putback’ of dodgy mortgage loans to FNM/FRE and/or the banks, or via a possible Muni implosion when the Build America Bond programme expires at year end.

Bigger yet is the threat posed by China’s inflationary outbreak. Although we derided its crude attempts to suppress prices and boost welfare payments – and while the market was briefly relieved that the PBoC did no more than hike reserve ratios for the umpteenth time – it does appear as if something a little more draconian may be coming down the track, possibly after the Central Economic Work Conference has discussed any such measures in three weeks’ time.

Certainly, if we are to take the China Daily at its word, we should be reducing risk exposures where we can: –

“…The latest move to contain excess liquidity and the forceful measures that the central government has taken to stabilize prices show the determination of Chinese policymakers to fight inflation. Though these moves may not be enough to tame inflation once and for all, they are a good start before more aggressive actions become necessary to battle inflation that is unlikely to end anytime soon, as debt-laden rich countries keep flooding the world economy with their newly printed money.”

Well, if Ben can blame it all on Zhou, he is surely entitled to give a little of it back, but the main point is that the former’s indulgence in QE might just be about to run into the latter’s switch to QT.  We know which we think will carry more weight in setting commodity prices.