Imagine a country where the average household routinely spends half its $100 income on buying in 4,000 calories a day of flour and half on all the other necessities, as well as the little luxuries, of life.
Next, picture the response if the subjectively perceived degree of scarcity of flour suddenly rises, pushing its price up 20% as it does. To keep matters as simple as possible, let us not delve too deeply into the whys and wherefores of this impetus, but simply let us insist it is not because of any actual shortage of physical supply on the cash market.
Assuming that demand for this staple of its members’ diet is close to an irreducible minimum, and that, in its anxiety to maintain its basic nutritional needs, the family will henceforth have to spend $60 on flour instead of $50 and so will be left with a mere $40 to devote to its purchases of everything else in place of the previous $50.
Supposing, too, that money in this benighted land is no longer an emergent construct of mutual intercourse and free exchange – and therefore, in some sense, ‘hard’ – but is rather issued without restraint, at the whim of a central collective of Platonic Guardians.
Let us further insist that Hoi Phylakes see it as their calling to ensure that the averaged prices of all things other than flour can never decline and, subject to some very woolly and ill-defined limits on how much politically insupportable harm they cause in the attempt, that no-one shall lack employment for reasons which a loose-thinker might attribute to a simple lack of money, no matter how sub-marginal or even blatantly unremunerative his labours might be.
Now, given that the jump in the price of flour has – at least as a first-round effect – led to only $4 being offered for a basket of goods which used to attract an offer of $5, the combined effect (differentiated among them as it will be in practice) is that they will fall in price by something of the order of 20%. Barring some miracle of instantaneous cost cutting, the total wage bill at the firms in that line of business will need to be reduced proportionately, meaning steep wage cuts or heavy job losses – each of them anathema to the Keynesian creed of orthodox economics.
Enter the central bank, stage right. If the lack of a post-flour disposable $10 (per household) has seen ‘deflation’ of such a hideous magnitude set in among the arbitrarily flour-excluding array of goods which it monitors, the instant addition of another $10 pro rata to the money supply should, it feels, set matters straight at once.
Alas for the conceit of the planner, for, as our original premise made clear, consumer preferences have decisively shifted in favour of buying flour not other goods, to settle at a new ratio of 60/40. Thus, the new exchangeable total of $110 (assuming the extra money to have been placed into the hands of the same family and not diverted off into some other passing fad or siphoned craftily into the pockets of the politically well-connected) is likely to have $66 of it used for flour and only $44 laid out on the rest, so ‘core deflation’ (in reality nothing of the sort, of course) will only have been ameliorated to -12% and not banished entirely, as was the naïve intention.
Chasing on through this battle of wills between the state and the individual – and still ignoring second order effects – an equilibrium might only be looked for when the supply of money has been artificially swollen by no less than a quarter – to $125 per household – whereat each family can spend three-fifths ($75) of this, as they desire to do, on flour and two-fifths – or the original $50 – on everything else and so finally eliminate ‘core consumer price deflation’ if only at the cost of magnifying the original, steep 20% rise in the price of flour to a vertiginous, final 50%.
Of course, that would not be an end of it, for none of this has masked a major alteration in the terms of trade between people in their (often simultaneous) roles as flour producers and consumers, nor between them in their non-flour equivalents. Ultimately, one set has benefited from the shift and one has lost out.
Granted, to the extent that flour producers and flour consumers are not entirely one and the same body of people and, hence, may express a varying menu of preferences, the former may seek to enjoy their relatively higher incomes by buying things other than flour for themselves and so partially mitigate the real effects on others.
Moreover, the change in relative pricing (something which would have taken its natural course even if there had there been no Ivory Tower full of academic meddlers and shallow special-pleaders) will have sent signals to people everywhere that they need to further adjust to a change of circumstances largely of their own creation. Thus, they might more closely review their use of the newly-expensive flour, making sure they maximise its utility and minimise any inefficiencies or identifiable excesses in its use.
They might devote care and attention to improving grain yields, bringing more land into cultivation, automating the milling process, easing the logistics of delivery to the point of sale, and even to developing alternative sources of sustenance.
Meanwhile, the producers of non-flour goods – who nonetheless also require their daily bread if they are to have the energy to man their own offices and factories – will seek to change the ratio between the necessary flour input (and, indeed, of any other inputs) and both the physical output – and, more importantly, the value entrained therein – of what they sell in order to earn that same bread, whether for personal consumption or productive uptake.
All in all, the initial shift in relative prices – however painful to those caught unawares by it and however threatening to those improvident enough to be conducting their business without an adequate reserve against this or any similarly unforeseen vicissitude – will incentivise savers to direct funds to those entrepreneurs whose own success will depend upon serving the currently expressed preferences of their customers better than their competitors and who, along the way, will slowly but surely lessen any constraints imposed by the original re-ordering of wants.
It cannot be too strongly emphasised that this would have happened whether or not the central bank had embarked upon its Canute-like programme of futile – or, rather, actively counter-productive – monetary infusions. These will only have multiplied the confusions over both the nature and the degree of the shift which was taking place and so delayed the implementation of the necessary schedule of adaptations, something which could have been most swiftly and least wastefully realised on an entirely unhampered market.
However, given the all-but inevitable fact of the Bank’s visitations, let us pause a moment to reckon the true achievements of our pecuniary Politburo in its vainglorious attempt to frustrate the workings of economic law.
Above all, it has thrown obstacles in the paths of both the consumers and the entrepreneurs who seek to direct the productive methods by which those same consumers’ efforts aim to satisfy their own needs – whether through offering their current labour or the savings which represent the unharvested fruits of their earlier labour.
It has effected an inequitable transfer of real wealth from creditors to debtors as a result of the sharp reduction in the value of the money in which the contracts between the two are written. It has probably done something similar to relations between counterparts at home and abroad through the effect on the currency exchange rate – something in which it will take a truly perverse degree of pride. In each case it will have made people more distrustful of acting according to that very division of labour, both across space and through time, which is what so enriches us all.
It has protracted and exacerbated the first, spontaneous rise in the price of flour with no better aim than to give everyone else the illusion that their stabilized nominal receipts have in some way compensated for their sharply fallen real ones – a cruel enough illusion if it succeeds: a fertile seed of social discontent if it does not.
It is also likely to have involved the heavy-handed intervention of the other organs of state power. These will probably stir up animosity towards the flour producers (especially if they live abroad) even to the point of penalising them retrospectively (an affront to natural justice) and so stripping them of both the motivation and the means to increase supply.
In their inept, après moi le déluge populism, they may well stoop to subsidising the consumption of that very flour which the public interest insists should be the subject of a much closer economy of use. They will probably invoke an aggressive policy of autarky, banning exports and paying tax- or inflation-dollars to homegrown Ersatz boondogglers while spreading the discord across the nations’ borders to the detriment of all concerned.
Never wasting a ‘good crisis’, all this will inevitably enhance the office-holders’ power of patronage and increase the rents paid to their cronies at the expense of the well-being of all other members of the commonwealth at large.
Finally, the central bank will have helped fuel an increasingly feverish round of financial market speculation – not just in flour but, as the all-too fungible money pours into the system and the itch to play with it becomes undeniable, in all manner of other things as well. ‘Speculators’ – the most active of them ironically housed within or financed by the central authority’s very own, cherished recipients of corporatist largesse and protection – will then provide a convenient scapegoat upon whom to deflect all criticism about the economic pain being suffered as the result of its own criminally misguided actions.
I hardly need to say that to substitute ‘oil’ for ‘flour’ or to specify one central bank in particular is to turn our little Gedanken economy into a passably close representative of the situation in which we all find ourselves today, one from which there seem to be all too few pathways not strewn with thorns, their paving of good intentions long-since broken up into a wearisome thoroughfare of jagged rocks and ankle-twisting potholes.
In fact, in command of the Federal Reserve is a coterie which is at once seeking to rationalise away its implication in rising commodity prices—the infamous argument about the cheaper, hedonised iPad2 being enough to mitigate the strain on household budgets imposed by the soaring price of necessities—and simultaneously relying upon a future deceleration in their rise to make subsequent year-on-year changes less contentious, simply by dint of the arithmetical ’basis effect.’
As well as being a decidedly obvious attempt at having things both ways, what we really have here is a hidden policy of rehashed, New Deal, price level targeting—i.e., price rises are not only not to be fought, but actively encouraged, so long as these erode both real debt levels and real wages, although it is also to be hoped that they do not increase for too long at the current rapid rate, lest that conditions an economic response which is only likely to see them spiral upward in a disastrously quickening fashion as echoes of Mises’ famous ‘crack-up boom’ begin to be heard.
Against this, the market has become somewhat fixated on what happens at the end of June when the current monetization of the misconduct of a derelict fiscal authority is due to end—an obsession which has some justification given that it has arguably been the single most important factor in a 32-week run which has led to the fastest, like-period gains in commodity prices since the first oil shock and to a rise in the S&P which, before being dampened by events in the Middle East and the Miyagi prefecture, had touched a rapidity only lately exceeded during the initial rebound from the GFC, the Tech Bubble, and the run-up to the Crash of ‘87.
Even if the winds are blowing against any immediate extension of this insanity, there seems little doubt that the Bernanke Fed is concreted into a position of chronic over-laxity and that if both asset prices and the macroeconomic aggregates subsequently start to suffer a bout of cold turkey, it will not be too long before the political calculus once again begins to coincide with the prejudicial leaning of the Chairman and his acolytes on the FOMC and some other, equally ill-advised measures are taken in response.
Two further market reactions may well prove conducive to such an early resumption of the game.
Firstly, much hinges on the fate of Treasury yields which will only have the support from any emergent ‘Risk Off’ move to help them and not the rather more tangible backstop of a near-100% central bank bid for net new debt. By seemingly ‘overtightening’ asset markets—and by dint of its possible repercussions for stock prices — this would see a widespread chorus of complaints—emanating from Wall St. as well as the Beltway—in favour of a prompt resumption of the policy of the printing press.
Secondly, any liquidation-led drop in key commodity prices—most notably oil – will strengthen the Fed’s hand in arguing, however speciously, that it was right all along not to compound the economically disruptive effects of a rapid rise in the stuff with a succession of higher interest rates, as was typically its response in the past.
Beyond the influence exerted by the Fed (and the policy paralysis evident at the BOE), we have seen the ECB make good on its threat to act just a little more responsibly when it raised its rates by 25bps and then backing this up with some reasonably forthright rhetoric which implies that the market is right to fear that there might be more in store where that came from.
In truth, we should not be as harsh about the bankers in Frankfurt as we are about their transatlantic peers, since the ECB has been reasonably successful in ring-fencing its emergency, quasi-fiscal role as financier of bust PIGS from its more typical function of providing liquidity to the system at large. So much so, in fact, that real Eurozone M1 is barely growing at all, having undergone its sharpest deceleration in at least thirty years—a grand aggregate phenomenon which presumably masks sharply divergent behaviour in a Germany where industrial production is rising at a trend 10% a year pace to within a whisker of its pre-Crash highs and the blighted, over-built periphery where the weeds are metaphorically springing up in the half-completed streets.
As for China, despite a swathe of surprisingly forthright local commentary underlining the inflationary horror which was unleashed by last year’s vast stimulus efforts, its central bank’s latest incremental tightening has been greeted with a yawn by a market both increasingly conditioned to such measures and wilfully optimistic that each such move simply hastens the great day when the series will end and we are off to the races again, trading everything frantically up on the wings of a newly invigorated Dragon.
That leaves as perhaps the most salient question to confront us as that relating to the side-effects of the BOJ’s programme of emergency liquidity injections, loan-support programmes, forex intervention, and—potentially—fiscal backstopping for another creakingly over-burdened state.
Already the Bank’s balance sheet has climbed to post-Lehman heights and the count of current account (reserve) balances has soared beyond all previous comparison, breaking the yen out against nearly every currency pairing of significance and taking risk reversals and basis swaps and other such positioning indicators with them.
The burning issue here, then, is this: in its misplaced anxiety to assist its people by showering them with money amid the rubble of their lives and homes, will the BOJ do enough to re-instate the yen as carry currency of choice and so negate any contractionary effects (however ephemeral) of the coming end of QE-II in the US?
That, my friends, is the $64 trillion question!
